ST BiH Factoring Eng - World Bankdocuments.worldbank.org/curated/en/440521468199442423/... · 2016-07-16 · factoring business modeling and analysis of different options of legal

FOR THE ESTABLISHMENT OF A FFFAAACCCTTTOOORRRIIINNNGGG CCCOOOMMMPPPAAANNNYYY IN BOSNIA AND HERZEGOVINA

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Feasibility Study - Factoring

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SEEDSoutheast Europe Enterprise DevelopmentALBANIA BOSNIA AND HERZEGOVINA FYR MACEDONIA SERBIA AND MONTENEGRO•• •

Hamdije Kreševljakovica 19/IV 71000 Sarajevo, Bosnia and Herzegovina

Tel.:(+387 33) 251-555; Fax: (+387-33) 217-762www.ifc.org/seed

HEADQUARTERS

Acknowledgements: While developing this study with its consultants’ team, SEED has interviewed a number of organizations and institutions that have provided important input data necessary for the factoring business modeling and analysis of different options of legal status of the Factoring Company. We have interviewed and had very useful discussions with numerous commercial banks representatives, representatives of the Central Bank of BiH, Federal Banking Agency, Investment Guarantee Agency, Banking Association FBiH, and Ministry of Finance both in the Federation of BiH and Republika Srpska. SEED is grateful for the time, inputs and cooperativeness that these organizations and institutions and their representatives have provided during the research phase of the development of this Study. Special thanks goes to our team of consultants; Prof. Milos Trifkovic whose expertise and broad experience in the area of business law provided in-depth analyses of BiH legal framework and recommendations with respect to having factoring business in place, and for adding value to overall Study, assuming the role of consulting editor; Ms. Mejra Juzbasic and her substantive contribution to our better understanding of banking and market potential issues facing factoring business in the country, Mr. Mahir Dzafic, whose input on taxation and accounting standards that influence the establishment and operations of potential factoring companies in Bosnia and Herzegovina was invaluable; and to Dr. Helmut Paris, international consultant on the team, with an expertise in factoring.


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TABLE OF CONTENT

1 EXECUTIVE SUMMARY.................................................................................. 7 1.1 Country Profile...................................................................................................7 1.2 Summary on Banking Sector and Market Potentials for Factoring in BH ................7 1.3 Summary of the Legal Environment ................................ ................................ .....8 1.4 Summary of the Accounting and Taxation Environment ........................................9

2 COUNTRY PROFILE.......................................................................................11 2.1 Political profile.................................................................................................11 2.2 Economic Profile ..............................................................................................12

3 BANKING SECTOR AND THE MARKET POTENTIALS FOR FACTORING IN BIH ...............................................................................................15

3.1 Banking Sector.................................................................................................15 3.2 Banking Supervision - Regulatory Bodies ..........................................................16 3.3 Other important laws regulating the banking sector .............................................17 3.4 Central Bank of Bosnia and Herzegovina (CBBH) ..............................................18 3.5 Factoring ..........................................................................................................19 3.6 Economic Trends ..............................................................................................20 3.7 Exports and SMEs............................................................................................21 3.8 Development of SMEs ......................................................................................23 3.9 Risk Coverage ..................................................................................................24 3.10 Potential Market for Domestic Factoring............................................................25 3.11 Market in other CEE countries ................................ ................................ ...........26 3.12 Recommendations ............................................................................................31

4 LEGAL ISSUES .................................................................................................32 4.1 Sources of Law .................................................................................................32 4.2 Subjects ................................ ................................ ................................ ...........33 4.3 Shareholders ....................................................................................................34 4.4 Insolvency Regulation................................ ................................ .......................35 4.5 Civil and Business Law Framework................................ ................................ ...36 4.6 Lending and Credit Contracts............................................................................38 4.7 Foreign Trade and Exchange Law Framework....................................................41 4.8 Recommendations ............................................................................................42

5 ACCOUNTING AND TAX ISSUES ................................................................44 5.1 Tax System in BH and Factoring................................ ................................ .......44 5.2 Company Income Tax................................ ................................ .......................45 5.3 Sales Tax .........................................................................................................48 5.4 Accounting Treatment of Factoring....................................................................50 5.5 Recommendat ions ............................................................................................54

6 STRATEGY, BUSINESS POLICY AND GENERAL RECOMENDATIONS 56

6.1 Strategy ................................ ................................ ................................ ...........56 6.2 Business Policy................................................................................................56 6.3 Final Analysis and General Recommendations ................................ ...................59


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SEEDSoutheast Europe Enterprise DevelopmentALBANIA BOSNIA AND HERZEGOVINA FYR MACEDONIA SERBIA AND MONTENEGRO•• •

Hamdije Kreševljakovica 19/IV 71000 Sarajevo, Bosnia and Herzegovina

Tel.:(+387 33) 251-555; Fax: (+387-33) 217-762www.ifc.org/seed

HEADQUARTERS

Terms of Reference Feasibility Study: Establishing of a factoring company in Bosnia and Herzegovina

A. Scope

The Project involves a comprehensive review of the environment for establishing factoring companies in Bosnia and Herzegovina. Besides working on a study on possibilities for establishing of factoring companies in Bosnia and Herzegovina, the consultant will look at the possibility to establish a single company that would serve demands of Bosnia and Herzegovina and Serbia. Consultants on the project will research, analyze, and draw conclusions and recommendations related to the legal environment amongst others. In particular, the SME sector will be investigated since the majority of factoring opportunities lies here and not in the moribund state-owned / socially owned sector. SEED will support consultants with on-the-ground legal advisers and through introduction to leading SMEs in the economy. The scope will include but not limited to the following: 1) General information about Bosnia and Herzegovina, esp. at it would relate to Factoring

(not to exceed 1/3 of the report) a) Summary of the legal environment b) Summary of the taxation environment c) Summary of the banking environment d) Overview of BiH banking systems

i) Are there banks specifically strong in financing exports? ii) BiH Banking Acts (incl. capital requirements, licensing process, F/X-regulations,

other important regulations and requirements) e) Other relevant observations about BiH as a business environment* * IFC has made a large investment into the banking sector in BiH. IBRD has concluded negotiations with BiH government on a new credit to improve the business environment. Further respective information may be insufficient to be included here.

2) The Environment for Factoring in BiH

a) General i) Basic considerations regarding Factoring within BiH financing system (incl.

whether Factoring is considered as banking product, and implications)

b) The Market i) Is there a potential market for export factoring in BiH ?

(1) Exports of consumer goods, with special focus on SME exporters (countries of destination, volume of these exports, current status of refinancing exports, export promotion by guarantees, profile of exporting companies, etc.)


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(2) How are exports being financed now (banks, L/C's, subsidised lending for exports etc)?

(3) How are exports guaranteed now (Insurance companies, "IMPEX” organisation etc)?

ii) Is there a potential market for domestic factoring in BiH?

(1) How SMEs finance their receivables right now (prepayments by buyers, bank lending, other)?

(2) Can factoring supplant expensive and hard to obtain revolving credits, which currently finance the bulk of SME working capital?

(3) Are there mechanisms to secure payments (insurance, bank guarantee, bill of exchange)?

iii) The buyers’ market:

(1) What is the structure of buyers for the potential products (consumer good): international chains v. "mama+papa" shop?

(2) What are the payment terms in consumer goods in the different buyer groups? (a) How are invoices being collected?

(iv) Marketing (1) What is the likelihood for BiH market to accept the “Factoring” product? (2) How to promote the Factoring product?

(v) Describe the development of Factoring markets in comparative countries in the first 3 years, and compare to the outlook for BiH.

c) Legal Issues

i) What legal requirements are necessary in order to have Factoring in place? Compare to the situation in BiH

ii) Legal status of factoring companies (bank versus trading company) iii) Impact of the legal status (different capital requirements, license, management

requirements, FX regulations within the financial services industry, etc.) iv) Is there a legal framework that makes the product “Factoring” possible? v) Is there a legal framework which influences the product “Factoring” (e.g. FX-

regulations) vi) Describe the FX-regulations influencing the Factoring business (keeping

accounts in FX, refinancing in FX, etc.) vii) How can receivables be assigned? viii) Is there any prohibition of assignment of receivables? ix) How can receivables be collected (general rules, legal procedures, etc.)? x) Other relevant legal issues

d) Tax Issues

i) Is there a tax framework that influences Factoring? ii) What is the tax treatment of Factoring in BiH? How does this compare to best practices? iii) Describe and analyse any transaction-based and/or other fees iv) Other relevant tax issues

e) Accounting Issues i) What accounting regulations are applicable for Factoring? Compare to IAS ii) What is the accounting treatment for the factor? Compare to IAS iii) What is the accounting treatment for the customer? Compare to IAS iv) Other relevant accounting issues.


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f) Other Issues

Other relevant issues related to the environment for Factoring in BiH 3) Summary, Comparison, Analysis and Recommendations

a) Summary of the current situation (legal, tax, accounting, market) in BiH versus the situation in countries with a developed factoring market. Outline var iances from best practices and provide related recommendation. Recommendations provided will be structured as follows:

(1) immediate importance (2) near-term importance (3) long-term importance

b) What is necessary to be done in order to create Factoring as a financing opportunity within BiH?

B. Deliverables:

1) Periodic written and verbal updates during the whole process (via e-mail, facsimile or phone); 2) Summary of recommendations of necessary legal changes; 3) An analysis of the financial sector, legal and regulatory environment, and potential

market of the factoring product in BiH that identifies key obstacles to the establishment of a factoring company;

4) A financial forecast for a BiH factoring company; 5) A business plan for a BiH factoring company; 6) A written report containing the information outlined in this proposal (in English language); draft report to be provided to SEED and IFC for comment; 7) Summary Report for BiH government, satisfactory to SEED and IFC, outlining the

study’s findings, listing needed changes to the regulatory environment (indicating the bases of the recommended changes)

8) One-day workshops in Sarajevo for stakeholders, including preparation of materials. D. Reporting:

International consultant and local consultants on the team were reporting to Mr. Davorin Pavelic, Senior Analyst and Ms. Azra Delalic, Program Asst. of Private Sector Development Team (PSD), but they worked with all team staff as appropriate in order to accomplish above-listed tasks.


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1 EXECUTIVE SUMMARY

1.1 Country Profile Bosnia and Herzegovina (BH) is situated in southern Central Europe's Balkan Peninsula, and covers the territory of 51.233 sqkm inhabited by 4.2 million people (according to the CBBH). Its capital is Sarajevo with a population of about 387.868, other major cities are: Banja Luka 220.407; Mostar 208.904; Tuzla 118.500; and Bihac 49.544. In Bosnia and Herzegovina there live three major ethnic groups: Bosniaks 48.1%, Croats 14.3%, and Serbs 37.1%.

Government: Bosnia and Herzegovina consists of two entities: the Federation of Bosnia-Herzegovina (FBiH) and the Republika Srpska (RS) and District Brcko. state architecture in RS and FBiH is not balanced. There are no cantons in RS. BH is the post-war country in transition. That is why in Bosnia -Herzegovina the political situation is more important for the country’s economic performance than is usually the case in developed market economies. Post-war-reality was the territory’s split into three separate areas, with the leading local players having the intention to limit co-operation among these areas to an absolute minimum. Open support for campaigns propagating a splitting-up has diminished substantially. The governments - now in power in Belgrade and Zagreb - have other priorities. Entities governments also have different priorities than a few years ago. Joining the EU is one of the most important among them. Salient features of the economic policy and regulation are numerous. Most important ones are: stable currency, SMEs as dominant type of enterprise, steady growth of FDI, in banking sector as a champion and foreign trade liberalization

1.2 Summary on Banking Sector and Market Potentials for Factoring in BH

During the last few years the banking sector in the BiH has shown a remarkable progress. It is mainly characterized by restructuring efforts to increase capital and capital adequacy, to manage liquidity and maturity mismatch and to introduce modern banking practice. This is the one of rare industries in BiH that experienced a major inflow of foreign direct investment. The bank privatization process has almost been completed and there are only a few remaining state banks to be privatized. One of the major improvements was establishment of the banking supervisory agencies as well. The Agencies were founded in the end of 1996 as independent institutions with the task of supervising the banks and issuing banking licenses, in order to ensure a stable and well-developed-banking sector. In order to protect the depositors of the banks, the Agencies have established numerous standards for banking operations and closely supervise the banks, in accordance with the BIS standards. However this will improve further since shortly both Agencies will come under the umbrella of the Central Bank of BiH (CBBH). The CBBH is apolitical and responsible for the monetary policy. It neither lends money to the government, nor does it provide loans to the commercial banks. It operates as a currency board and it is additionally mandated by the Dayton Peace Accords to safeguard the official domestic currency, the Convertible Mark (KM, Konvertibilna Marka).


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Bank consolidation, driven by the new Law on Banks and other banking regulations, is also taking an important role in the overall improvement of the banking sector. Currently there are 40 banks in the BiH, 28 banks in the Federation of BiH and 12 in the Republika Srpska (RS). The number is still large but in comparison to 54 banks only in the Federation of BiH during 1998-1999, it is inevitable that the bank consolidation and privatization have shown remarkably positive results. Hence, a significant increase of deposits, loan volumes and profits was recorded, but in spite of that the volume of capital in the BiH banks is generally low due to still high volume of non-performing loans, inefficient judiciary system especially in respect of collection of outstanding receivables, and low earnings. Even though assets quality has improved and the liquidity of the BH banks is not a problem, the problem arises when those surpluses have to be invested. Since the assets-liability management (ALM) and risk management are still underdeveloped these surpluses are often kept with foreign banks. Moreover, the lack of long-term funding creates additional problems in respect of ALM Even though the banking sector of the BiH experienced major consolidation and progress, BiH is still "over -banked". The bank consolidation will have to continue with faster pace especially because of the very tough competition and regulations of the banking and financial sector.

1.3 Summary of the Legal Environment There are no specific laws or regulations on factoring in BiH, but the necessary legal framework is existing. The following acts listed below define the legal base for the factoring business: ?? IPL Act – autonomy of the parties and collision norms ?? Obligation Code:

o Cession (art. 436 – 445) o Sale of rights (art. 454 – 551) o Loan (art. 556 – 557) o Commission and Delcredere (art. 771 – 789)

?? Company Law ?? Company Registration Act ?? Bankruptcy Act ?? Liquidation Act ?? Law on Execution Procedure ?? Law on Foreign Trade Policy ?? Law on the Policy of Direct Foreign Investments ?? Law on Foreign Currency Operations.

The Obligation Code (OC) provides comprehensive regulation of general contract law and commercial variations thereto. The Art. 436 – 445 of the OC provide the framework for the assignment of receivables and for the relationship between assignor, assignee and debtor. There is a new OC Draft which does not regulate factoring, but contains provisions favorable to it The registration of a factoring company has to be applied at the competent court and it will be registered like any other company in BiH. If the company is planning to enter into international business, there are some additional registration requirements.


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Factoring can be offered by: ?? a bank ?? a limited liability company ?? a joint stock company

If a Bank intends to be shareholder in a factoring company, it needs prior approval of the Banking Agency, in case the investment is exceeding 5% of the bank’s equity and/or the total net value of the banks equity in other companies exceeds 20% of the banks own equity. In case of international factoring the very liberal exchange regulations will affect the business. Foreign exchange payments abroad must be performed by banks. The new Law on Bankruptcy is in force since 2003. It is favorable to factoring. Collection of claims against non-performing clients can be difficult and time consuming. Laws on registration of property and mortgages remain underdeveloped and non-registered collateral on movables is not operative as yet. However, laws being important for the business are in place and courts are learning to deal with the overall changes. Legal action starts in the municipal court. Enforced performance on money assets in bank accounts is specifically regulated. According to information from the courts in Sarajevo, execution procedure lasts at most 10 days after the execution request was received. Lawyers consider execution on accounts in thirty days a pretty good outcome. The new Execution procedure act will speed up this procedure.

1.4 Summary of the Accounting and Taxation Environment The two Entities and the Brcko District are fiscally independent. Therefore three tax systems are existing, but it must be mentioned that, with respect to the sales tax, there are only few differences between them. For the time being single phase-tax is applied. Introduction of VAT is expected in 2005. The following laws and regulations may effect Factoring in BiH: ?? Laws on Sales Tax ?? Rulebooks on implementation of the Law on Sales Tax ?? Laws on Company Income Tax ?? Rulebooks on implementation of the Law on Company Income Tax

In case of non-payment by a debtor, creditor must in the Federation BiH to file a law suit. Non sued receivable, which has been written off, increases the taxable profits. This is not the case in Republic of Srpska. Income-tax is on the level of 30% in the Federation BiH, but a broad spectrum of cumulative applicable tax applicable tax reduction possibilities are in use. In Republic of Srpska the rate is only 10% but tax exemptions are much fewer. Export services and credit services for banks only, are exempt of sales service tax.


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A particular problem is the lack of harmonization of taxation of services between the entities. Accounting standards are in line with the International Accounting Standards – IAS. There are some parts where they deviate or they were not yet adopted. Most important for Factoring – the Standard 39 Financial Instruments: Recognition and Measurement has not been adopted- So, the recognition and valuation of the financial assets and liabilities in BH remain out of IAS reach.


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2 COUNTRY PROFILE

2.1 Political profile Declarations of independence by this and other former republics of the Socialist Federal Republic of Yugoslavia (Croatia and Slovenia) led to the 1992-95 war over BiH territory. On 21st November 1995 the Dayton Peace Agreement was signed and supported by Western nations. Thus the true independence for BiH was established. The civil implementation of the Dayton Agreement is guided by the Office of the High Representative. The representatives of the International Community are pushing for more responsibilities to be given to the central government as well as for a harmonization of laws and regulations. Bosnia and Herzegovina is a sovereign democratic state, created by public referendum and recognized by the UN. After the war from 1992 to 1995 the Dayton Agreement reinstated the democratic government and split its territory in two multiethnic entities: the Federation of BiH comprises 51 % of the country, the Republika Srpska 49 %. The Dayton Agreement retained BiH’s international boundaries, reinstated a joint multi-ethnic and democratic government, and split its territory into two multiethnic entities: the Federation of BiH, with a shared Bosnian Croat (Catholic)-Bosniak (Muslim) post-war majority, comprises 51 % of the country, and the Republika Srpska (RS), with a Bosnian Serb (Orthodox) post-war majority, which comprises 49 %. The territory of Brcko District is under the administration of the BiH state as a separated District according to the arbitration award of the Commission. The Federation is divided into 10 cantons, each with respective Assemblies and Governments, displaying federal state-like features in their administration: 1. Unsko-sanski Canton 2. Posavski Canton 3. Tuzlanski Canton 4. Zenicko-dobojski Canton 5. Bosansko-podrinjski Canton 6. Srednjobosanski Canton 7. Hercegovacko-neretvanski Canton 8. Zapadno-hercegovacki Canton 9. Sarajevo Canton 10. Hercegbosanski Canton The Republika Srpska is administratively divided on 5 regions: 1. Banja Luka region 2. Doboj region 3. Bijeljina region 4. Sarajevsko-romanijska region 5. Trebinje region Cantons and regions are further divided into municipalities.


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The Dayton-mandated BiH Constitution1 centers around a central government with a bicameral legislature, a joint presidency comprising a Bosniak, a Croat and a Serb, a Council of Ministers (including the Ministry of Foreign Affairs, the Ministry of Economic Development and Foreign Trade, and the Ministry of Communication and Civil Affairs), a Constitutional Court and a Central Bank. In April 2000 the Council of Ministers established three new ministries: the Ministry of European Integration, the Ministry of Human Rights and Refugees and the Treasury. This state government is charged with conducting foreign and economic policy. Currently under the guidance of the High Representative and International Community the political parties are preparing the amendments on the Law on Councils of Ministers i.e. the new Ministries will be introduced on the State level. Additionally, Dayton Agreement grants each entity authority to maintain an army, under the ultimate control of the joint presidency, and it guarantees freedom of movement between entities and the rights of refugees and displaced persons to return to their homes. Civil implementation of Dayton is overseen by the Office of the High Representative (OHR), headed by international officials with broad enforcement powers to further integrate the country. Overall peace is guaranteed by NATO-led troops. The Federation's Central Government and Republika Srpska’s Central Government are solely responsible for development of economic policies and all affairs not expressly assigned to the state of Bosnia and Herzegovina. The creation of a Central Bank for the country as a whole was an important first step. In other economic fields, the country de facto continuous to be divided into three ethnically defined areas. The reform discussion has emerged in a situation of shrinking funds for BiH relating activities. The relations between local politicians and representatives of the International Community are a sensitive issue. International donors contributed substantially to last year’s political and economic achievements, also financially. The International Community produces regulations, institutions and support schemes every day. The local society has to integrate them into their daily life, otherwise they are of limited use. The Federation’s central government and Republika Srpska’s central government are responsible for the development of economic policies and all affairs not expressly assigned to the state of Bosnia and Herzegovina.

2.2 Economic Profile Due to the interruption of the economic development caused by the war the quality of statistical data is poor. Currency: 1 Euro = KM 1,95583.GDP per capita 2001: FBiH 2.570 KM; RS 2.176 KM The black and gray economy is rather sizably including unrecorded imports and exports. GDP 2001: KM 10.2 billion (FBiH KM 7,2 billion; RS KM 3,0 billion)

1 1. Presidency of Bosnia and Herzegovina 2. Parliamentary Assembly of Bosnia and Herzegovina - House of Representatives - People’s House 3. Council of Ministers 4. Constitutional Co urt


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The GDP growth rates are rough estimates lacking a sufficient statistical basis. The IMF estimate for 2001 is 7% for the FBiH and 1,9% for the RS. Possibly these estimates are too optimistic and the same may be true for the estimates up to 2006. In a reform scenario the growth rates are 5,1% in 2002 and 6% from 2003 to 2006 whereas in a status quo scenario there are 4% for 2002 and 3,5% for 2003 to 2006. The economy’s basic problem is the high share of debt-burdened and loss making enterprises in the corporate sector. Preliminary industrial production growth figures indicate a sharp discrepancy between the performances of the two entities. The Federation’s industrial output grows while the RS’ recorded a decline. Generally speaking industrial production is far below pre-war volumes. Another indicator of the still exceptional situation is the extremely high unemployment. The officially reported rate is about 40%. Thanks to the currency board regime implying a fixed peg to the Euro, inflation is not a major problem. Given the huge deficit in the current account (approximately 1 billion Euro) the countries financial problem is obvious. So far, there was enough capital inflow, but it was not a market-generated inflow. In agriculture, forestry, mining, manufacturing and construction production has recovered only partially after the war. The value added, created in the tertiary sector represents a high share in total GDP. This imbalance is putting brakes on overall economic progress. In manufacturing, enterprises often are suffering from lack in working capital. Especially big companies from former times have accumulated debt they can not service. Small and medium-sized enterprises and start-ups are confronted with a hostile business environment. The weakness of the BiH manufacturing sector becomes obvious from the foreign trade data. The trade deficit is still higher than the current account deficit. On local markets they often can not compete with imports, especially if the latter have entered the country illegally and thus free of tax and custom duties. As regards foreign markets, companies do not have the funds necessary for gaining market shares abroad. The banking industry has experienced a major inflow of foreign direct investments. Now the major part of commercial banking can be regarded as sound. There are still difficulties with the supply of favorable long-term loans. The market for long-term loans cannot develop because of the lack of adequate infrastructure. Due to institutional shortcomings, lenders have enormous difficulties recovering receivables in the case of default. An inefficient judiciary system is part of the problem. Foreign direct investment could promote production, but foreign direct investment does not flow in just when a country would need it. Conditions for doing profitable business have to be in place. In BiH a foreign investment law was enacted at the state level. In spite of huge efforts towards reforming and harmonizing legal structures barriers are still manifold. Laws and regulations at the state, entity, cantonal and municipality level are often contradictory or duplicative. A study of the Foreign Investment Advisory Service (FIAS) concludes, the existing commercial, legal and regulatory framework is based on a labyrinth of formal and informal rules. The inconsistency and non-transparency of regulations and administrative procedures create opportunities for corruption and abuse of power. Effective and independent mechanisms for appeals are absent. The International Community put much effort into the reconstruction of energy networks and the infrastructure for transports and telecommunication, as a pre-condition for economic recovery and progress. Nevertheless, in many segments of these sectors the degree of utilization and efficiency are low. The reason behind is the still prev ailing split of the country into three areas. In the last two years considerable efforts were made concerning trade liberalization within the South East European region.


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The already existing bilateral free trade agreements will be expanded. When fully implemented, the South East European region will become more attractive to domestic and international investors. This should improve the economic environment fundamentally. It is not likely that the long-lasting downsizing of the industrial and manufacturing part of the economy going together with the high unemployment rate can be interpreted as lack of entrepreneurial spirit of the people. Starting a business of their own, alone or in co-operation with others, is difficult for jobless people everywhere in the world, especially in transition countries. There is not only a lack of own funds, it is also the unwillingness of banks and other financial institutions to finance start-ups. This situation will be substantially improved by the implementation of further para banking instruments - like factoring – to the overall benefit of the BiH economy.


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3 BANKING SECTOR AND THE MARKET POTENTIALS FOR FACTORING IN BIH

Mejra Juzbašic

3.1 Banking Sector In the recent period the Banking Sector in the BiH has been significantly improved and characterized by efforts to increase capital and capital adequacy, to manage liquidity and maturity mismatch in the way to ensure adequate resources for lending and depositor withdrawals, and to become more competitive. A progress has been recorded in the Federation BiH but in RS banks are significantly behind. Even though these objectives have been partially met the total capital of the banking sector in BiH is still very low, and at 31st December 2002 amounted to KM 1.2 billion, where the total assets amounted to KM 6.3 billion. This trend of capital increase will continue due to the minimum capital requirement of KM 15 million, which has to be met by 31st December 2002. As many banks will not be able to meet this capital requirement, they will have to be either merged or liquidated. However, given the country's depressed, but improving economic status, BiH is still "over-banked". For the future there are expectations that required equity amount will grow which will contribute to further strengthening the banking sector. The bank consolidation has to continue with faster pace due to the very tough competition and regulations of the banking and financial sector in BiH to qualify for membership in the deposit insurance fund, and to meet minimum capital requirement. Contrary to the apprehensions only 3 banks did not fulfill the 15 mln requirement: Privredna banka Sarajevo, Central profit banka Sarajevo and Post Bank BH. PBS and CPB got an extension up to the 31.12.2003 to fulfill the requirement. Regarding Post Bank (100% state owned) no measures have been taken, since the Bank is subject to privatization. Currently there are 40 banks in the BiH, 28 banks in the Federation of BiH and 12 in the Republika Srpska (RS). The number is still large but in comparison to 54 banks in the Federation during 1998-1999, the bank consolidation and privatization has shown very positive results. Also, a significant increase of deposits, loan volumes and profits was recorded. In December 2002 the amount of extended loans by banks was KM 3.787 mil. out of which loans granted to companies amounted KM 2.670 mil. and to other private sector KM 1.117 mil. Interest rate range is between 10 – 14%, and the average interest rate on short-term credits is 12,6% and on long term credit is 10,8%. Average interest rate on demand deposits is 1,4%, and on savings is 4,5 %. The privatization of banks in the Federation has almos t been completed and there are only a few remaining state-owned banks in the process of being privatized (Union Banka d.d. Sarajevo, Postbank BH – Poštanska Banka d.d Sarajevo), restructured into a development agency (Federal Investment Bank), or under the provisional administration (Gospodarska banka d.d. Mostar, Mostarska gospodarska banka d.d. Mostar, Hercegovacka banka d.d. Mostar, Una banka d.d. Bihac). Seven banks are 100% and another 10 banks are majority owned by foreign investors. In the Federation BiH the number of banks will continue to decrease since there are further merging plans of existing banks, and also the inability of some banks to meet the capital


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requirement. This will have a positive impact on the overall economy, and it will lead toward strengthening the capital base of BH banks. Among the foreign banks present in the Federation of Bosnia are Raiffeisen, Volksbank, Hypo Alpe Adria Bank, HVB Bank, Unicredito/Zagrebacka Banka (Italy/Croatia), Bosna Bank International, Turkish Ziraat. In Republika Srpska there are three majority foreign-owned banks: Balkan Investment Bank/Ukiobankis (Lithuania), Nova banjalucka banka/ Komercijalna banka Beograd, Zepter Commerc Bank / Zepter Holding. Even though the banks in the Republika Srpska banks are very small, they have been slower to consolidate. There was very little new investment that entered the RS market. Total assets in RS in 2002 amounted to KM 1.3 billion, and there are still minority stakes held by the government. This number of banks will have to decrease as well, since this number of banks will not be able to function in this size market in the coming period.

3.2 Banking Supervision - Regulatory Bodies Over the past few years there has been a significant improvement recorded in this area. This was a result of the establishment of Federal Banking Agency (FBA) and Banking Agency in Republika Srpska (BA-RS). The Agencies were founded in the end of 1996 as independent institutions with the task of supervising the banks and issuing banking licenses, in order to ensure a stable and well-developed banking sector. In order to protect the depositors of the banks, the Agencies have established numerous standards for banking operations and closely supervise the banks, in accordance with the BIS standards. The main responsibilities of the Agencies are: ?? Supervision of banks both on- and off-sight ?? Licensing ?? Liquidation

A new Law on Banks (Official Gazette of the F BiH 39/98, 32/00, 48/01 and 41/02) contains precise guidelines for FBA activities. There are no major differences in the Law on Banks of the Republika Srpska. Pursuant to this Law banks need to obtain their license from the Banking Agency, and no institution can accept money deposits nor grant loans without having this license. However, the loans granted by the microcredit nonprofit organizations are not subject to these regulations. The request for a banking license has to be submitted to the banking agency in writing and has to contain the following information: ?? The contract on establishing a bank, signed by all founders, draft of statute and other

articles of associations ?? Data on qualification of members of Supervisory board and Management of the bank ?? The amount of shareholders’ capital, total and core capital ?? Plan and projection of business operations, and organization scheme of the bank ?? List of owners.

The Agency has to pass a decision regarding the issuance of license within 60 days from the day the request is received, and then the bank has to register at the court within 30 days from


17

the day the license is issued. If the court registration is not completed within 90 days, the Agency can revoke the license. Moreover, the Agency will issue the license for establishment of a bank’s subsidiary, which is headquartered outside the Federation/Republika Srpska, only if the bank has a license issued by the authorized institution for the supervision of that foreign bank. The branches of foreign banks have to obtain the approval form the Agency as well. The Agency may revoke the license if the bank does not meet the capital requirement, does not accept deposits/grant loans longer than 6 months, does not qualify for membership in the deposit insurance fund, or for some other reasons specified by the Law on Banks. Hence, all banks are obliged to control and to analyze the quality of credit and likelihood of collection. The Agency takes charge of corrective actions that bank management is unable to solve.

3.3 Other important laws regulating the banking sector

3.3.1 The Law on Foreign exchange (F/X) This Law regulates payment transactions between persons in the Federation and natural and legal persons abroad, foreign exchange market in the Federation, foreign exchange deals, as well as authorizations of the banks in this process. The foreign payment transactions are executed through banks, and only the Ministry of Finance of the Federation BiH may approve the direct settlement of the domestic companies with abroad. Each domestic legal person is obliged to collect the payment for exported goods within 90 days, if cash payment is contracted, or within the deadline prescribed in the loan agreement if a loan is granted. However, the Ministry of Finance F BiH can approve the collection within a period longer than 90 days, if there is either cash payment or the payment terms determined in the loan agreement. Moreover, a company which exports and imports goods based on the long-term cooperation agreement can contract the payments and collections with person from abroad, through the current account by settlement of receivables and payables. Balance of receivables on the current account cannot exceed 40% of total exports amount for the current year. If that happens the Ministry shall order the settlement or collection within 90 days. Also certain penalties are prescribed in case the Law is not followed.

3.3.2 The Law on Deposit Insurance The Law on Deposit Insurance regulates deposit insurance of natural and legal entities in local and foreign currency in banks that meet the requirements. Also, the Law regulates establishment, status, operations, governance and management of the Deposit Insurance Agency in Federation of Bosnia and Herzegovina. The highest amount of deposit that is insured by the Agency is KM 5.000.

3.3.3 Laws and Regulations in Relation to Capital Markets One of the objectives in the transition process towards market economy is the establishment of capital markets. The following legal framework determines capital markets in the FBiH: ?? Law on Securities ?? Law on the Commission for Securities in FBiH ?? Law on the Securities Registrar ?? Law on Busin ess Companies


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Institutions responsible for the capital markets in FBiH are Securities Commission and Registrar of Securities. Securities Commission The Securities Commission of the Federation of Bosnia and Herzegovina (FBiH) is an independent institution established in 1999 to regulate, approve and supervise issuance and trading of Securities in FBiH. The Commission is the supreme regulatory body in the area of capital markets and is tasked with the establishment and development of the infrastructure of the capital markets. The Commission has five commissioners who serve for a term of five years. Registrar of Securities The Registrar of Securities conducts activities of registration, safekeeping and maintaining information on securities, as well as activities of securities transfer, in accordance with the law regulating the issuance and trading of securities.

3.3.4 Other Laws Professional appraisers and Real Estate brokers in the BiH do not yet meet western standards, and process servers are unavailable. Collection of claims against non-performing clients can be difficult and time-consuming. Laws on registration of movables and mortgages remain underdeveloped. The Law on registered Pledges has been passed, but its implementation did not start as yet because information system is not finished. However, other laws being important for the banking sector are in place, and courts are learning to deal with the overall changes. Pertinent laws include: ?? Law on Money Laundering ?? Law on Obligations, determining all cond itions of free trade of goods and services. ?? Law on Registrar of Securities, regulating the stock market. ?? Law on Court Registration, regulating the registration of companies. ?? Procedural laws , regulating different legal procedures.

3.4 Central Bank of Bosnia and Herzegovina (CBBH) The Central Bank of Bosnia and Herzegovina (Centralna Banka Bosne i Hercegovine) began to operate as the sole authority for the country's currency and monetary policy on August 11th, 1997. It operates as a currency board and it is additionally mandated by the Dayton Peace Accords to safeguard the official domestic currency, the Convertible Mark (KM, Konvertibilna Marka). Under guidelines drafted with help of the IMF, the CBBH maintained a reserve amount of liquid German Marks, which was backed 1 to 1 with the KM. With the introduction of Euro, CBBH maintains a reserve amount in Euro. CBBH is obliged to maintain foreign currency reserves of at least 1 to 1 of local currency in circulation. Other important facts in relation to CBBiH: ?? The Konvertibilna Marka (KM) is the first nation-wide legal tender in Bosnia and

Herzegovina since war broke out in 1992.


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?? The CBBH controls monetary policy in the country and is apolitical. It does not lend money to the government, it does not provide credits or guaranties, and it is not a lender of last resort to the banking system.

?? Since the DEM’s inclusion into the European single currency, assets held by the CBBH are tied to the EURO.

?? The KM is freely convertible at any Bosnian commercial bank (Euro 1 : KM 1.95583).

?? Upon liquidation of ZPP2, the CBBH supports and maintains payment and settlement systems. It also co-ordinates the activities of the banking agencies, of the BiH entities which are in charge of banking licensing and supervision, as well as the Insurance Deposit Agency at the state level.

3.5 Factoring Officially there is no factoring business in BiH. For this type of business activity better financial information systems are required, as well as stronger creditor protection. Also legal support and corresponding laws will be needed to provide framework for implementation of this product. However, due to strong presence of foreign-owned banks on BiH market it is possible that this type of activity will be introduced

3.5.1 Potential Market for Development of Factoring A large industrial base and capable companies that produced aircraft and machine tools, and other complex goods characterized the pre-war period in the early nineties. Large-scale industry generated about half the output and employment, ranging from energy and raw material sectors (wood and coke production, coal and bauxite mining), to the production of electrical and machinery equipment, textiles, leather and footwear. Civil engineering and agricultural food processing were equally developed. Unlike other centrally-planned economies, former Yugoslavia's economic system was based on market socialism and self management, allowing for some competition in the product market, but generally restricting competition and mobility in labor and financial markets. State banks supplied the sole source of capital, and bank credit offered the only means for financing ventures. These banks were owned and controlled by large state enterprises, which used them to obtain favorable financing terms. The war destroyed a lot of the country’s infrastructure and severely disrupted its economic life. In 1990, BiH had a GDP of US$ 11 bln and a per capita income of US$ 2,400. By 1995, GDP amounted US$ 2 bln, per capita income was estimated at US$ 500 and external debt was US$ 3 bln. Industrial production had fallen to 10% of its pre-war level and unemployment had risen to 80%. With the assistance of the World Bank, the European Commission and other donors, in 1995 a four-to-five-year recovery program was designed to fund reconstruction in infrastructure, social sector, agriculture and other sectors. By the end of 2002, road, telecom, power, water and education services were expected to be at or near pre-war levels. 2 ZPP (former domestic payment bureau) was closed on January 5th , 2001, when the banks took over the domestic payment system. According to the Federal Banking Agency from that date until September 2001, banks performed KM 13.5 m of payment transactions in total of KM 25.7 bn.


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In May 1998, the authorities embarked on an ambitious economic reform program, supported by adjustment credits form the International Development Association and an International Monetary Fund Stand-By Agreement. The objectives of this program were to create a unified economic space and a functioning banking system, privatize and restructure enterprises, reform the labor market, reshape pension and health systems, implement a simplified customs regime and liberalize the trade regime. Underlying these reforms was an ongoing macroeconomic stabilization program based on a currency board arrangement accompanied by strict fiscal discipline. The most successful achievement over the past few years has been the full establishment of the BIH Central Bank and the launch of its currency - the Konvertibilna Marka that is pegged to the Euro. Other achievements include the adoption of a liberal countrywide customs tariff regime and a substantial increase of inter -entity trade. Unemployment remains the major challenge to economic development. While reconstruction and recovery have brought generalized improvement in welfare – with per capita income more than doubling since the end of the war – the unemployed and several other vulnerable groups including the internally displaced (refugees) do not benefit from this strong post-war growth. The Bosnian economy has continued to grow relatively rapidly, reflecting the ongoing recovery from the devastating war of 1992-95. Real GDP, however, is still only about half the pre-war level. The high growth rates of the recent years have been sustained by external aid rather than private investment, and a continuation of growth requires the pace of structural reform to be accelerated significantly. There was also a significant imbalance between the two territorial entities, with GDP in the RS estimated at only 75% of the country average.

3.6 Economic Trends3 Due to the interruption of the social and economic trends caused by the war, the quality of the statistical data is still poor. Another factor not statistically document ed is that the black and gray economy is rather sizable, including large unrecorded imports and exports and cash transfers from emigrants and guest workers abroad. The Gross Domestic Product (GDP) of the BiH in 2000 amounted to KM 9.4 billion (Federation BiH amounted to KM 6.7 billion, RS KM 2.7 billion). GDP per capita in BiH amounted to KM 2.209 in 2000 (F BiH KM 2.392, RS KM 1.861). This indicator is still very low comparing to other European countries, and shows that BiH is one of the poorest countries in the region. In 2001 the nominal GDP of the BiH amounted to KM 10.2 billion (F BiH KM 7,2 billion, RS KM 3,0 billion). GDP per capita in F BiH was 2.570 KM and in RS 2.055 KM. Inflation in December 2000 in the Federation BiH was 4% and fell further in the year 2001, and in first quarter of 2002 was negative, while in RS was 0.6%, as a consequence of the constitution of the currency board and the implementation of tight monetary policy. Therefore, economic growth and exports could only be financed by large amounts of foreign aid and loans. However, this type of capital inflow will most likely decrease in the future. In the first quarter 2002, industrial production in the Federation BiH decreased by 2.3% in comparison to the average production recorded in the year 2001, and compared to the same

3 Data obtained from CBBH


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period of 2001 it is higher by 4.8%. The industrial production in Republika Srpska recorded a downward trend in 2002, decreasing by 11.5%, as compared to the average production in 2001. In total year 2002 the industrial production in the F BiH increased by 9,2% as compared to the same period in 2001. In the same period the industrial production in RS decreased by 2,5%. In 2002, the total retail price and living cost index in the Federation was lower than the figure recorded in Republika Srpska. Retail prices in the Federation in 2002 decreased by 0.2% as compared to the average retail prices in 2001, while in Republika Srpska in 2002 the total retail prices decreased by 1,7% as compared to the average retail prices given for 2001. In the first quarter of 2002, the total living costs in the Federation BiH increased by 1,1% compared to the average living costs in 2001, while in Republika Srpska the total living costs increased by 1,9%. In December 2002, in the BiH the average gross wage amounted to KM 686, and average net wage KM 463. In the Federation the average gross wage amounted to KM 754, and average net wage KM 513. This represented an increase of 15,6% compared to the average net wages paid in 2001, and increase of 12% compared to the average net wages paid in December 2001. In the RS in December 2001, the average gross wage amounted to KM 542, and average net wage was KM 356. This represents an increase of 15,2% and by 7,2% compared to the average net wage paid in 2001 and in December 2001 respectively. The unemployment rate in both F BiH and RS remains horrendous about 40%. According to the above the growth patterns indicate that recovery is led by small and medium enterprises in the services and light industry sectors, likely to be leaders of growth in the medium term.

3.7 Exports and SMEs One of the major obstacles to sustainable development is imbalance of exports and imports that has prevailed both in the Federation BiH and in the Republika Srpska. T he value of imports in the Federation BiH was nearly four times that of the exports. The value of imported goods amounted to KM 5.730 million, while the value of exported goods totaled KM 1.524 million. The percentage of coverage of imports by exports in 2002 was 26,1%. In Republika Srpska the negative trade balance in the year 2002 amounted to KM 1.599 million, and the percentage of coverage of imports by exports was 25.9%. BiH is mainly exporting its goods to Yugoslavia, Italy, Germany, Croatia and Switzerland. Switzerland is the only BiH trading partner where BiH had a trade surplus.


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Table 1. Export trading partners4 (KM 000)

EXPORT

COUNTRY

BIH FBIH RS YUGOSLAVIA 417.271 139.403 277.868 ITALY 246.524 183.575 62.949 CROATIA 311.553 261.073 50.480 GERMANY 262.360 232.613 29.747 SWITZERLAND 229.965 222.808 7.157 SLOVENIA 174.070 140.307 33.763 AUSTRIA 83.543 71.815 11.728 FRANCE 41.707 37.468 4.239 USA 26.590 25.603 987 MACEDONIA 19.500 11.679 7.821 TURKEY 12.920 10.477 2.443 HUNGARY 12.931 8.111 4.820 OTHER 250.718 179.073 71.645 TOTAL 2.089.652 1.524.005 565.647 The following is the review of the amount of exports and imports financed through commercial banks in the BiH: (in 000 KM) Item

Customs Data

Commercial Banks

% of financing through Commercial Banks

(1) (2) (3=2/1*100) Exports 1.489.620 1.335.090 89.6% Import 5.668.812 4.749.115 83,8% According to the data of the Chamber of Commerce of BiH, the major exporting5 products of the BiH are; forestry and corresponding services, wood and wood products, furniture, basic metals, textile, leather and footwear, and electricity, gas and water supply. The BiH has significant capacities in the wood industry, mainly determined for export production. Forests and woodland cover about 53% of BiH in area. There are a number of saw mill capacities for wood processing in BiH: hence about 2.000.000 m3 of wood can be processed. Since the final processing of wood is not well developed yet, the significant amounts have been exported. There are a lot of furniture production companies, and since this production exceeds the need of Bosnian market, a significant amount of furniture has been exported, mainly to Germany, Italy, France, England, Hungary, Slovakia, Yugoslavia, Croatia, Australia, USA, and to Asia as well.

4 Central Bank of BiH 5 The data on the amount of exports corresponds to the Federation of BiH, Federal Bureau of statistics


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About 90% of the textile, leather and footwear products are produced for already known foreign buyers. Even though there are capacities for production of cotton fabrics, such production does not exist, and it is imported. However, in Mostar there is one cotton mill bought by a Norwegian investor, and the beginning of production is expected soon. Moreover, the agriculture resources in BiH were also highly affected by the war, about 50% of the total mechanization of the agriculture production has been destroyed. This production was very significant before the war, and still there are very significant capacities for this type of production. Currently the accent is put on the production of healthy food, without using any pesticides. BiH’s mineral water is very well known all over the world: Sarajevski kiseljak, Oaza Tesanj, Ilidzanski dijamant, Vitinka Kozluk. There are also very well known vines: Zilavka and Blatina, and also livanjski and travnicki cheese (Lura milk factory Livno, and Poljorad Turbe). The State of BiH is granting subsidized loans in order to support the exports of these products. Also BiH is exporting natural ingredients for tea and medicine production.

3.8 Development of SMEs A big part of the production mentioned above is executed by the SMEs. The future of Bosnia and Herzegovina mainly depends on the development of the SME sector. Small and medium sized enterprises (SMEs) play a central role in developing countries, socially as well as economically. They have a hard time, struggling against difficult local business environments and are rarely able to obtain the financing and other forms of support they need. Currently in BiH favorable business environment for the development of SMEs does not exist: ?? weak connection with international companies, ?? domestic pre-war big companies do not function; ?? insufficient access to financing, ?? lack of technological development, etc.

In 1991 there were 17.573 SMEs registered, while in 2001 only in the Federation of BiH 16.785 companies are registered. However most of them are very small: ?? up to 9 employees 13.847 ?? 10-49 employees 2.102 ?? 50 – 250 employees 691

There are 145 companies with more than 250 employees only In the Federation BiH there are about 33.000 independent shop owners. In order to develop a better business environment banks in the BiH are trying to provide favorable financing for SMEs and the private sector. For instance, the Federal Investment Bank (IBF ) in the period 1998 – 2001 granted 959.000 loans totaling to KM 219.891 thousands. As at 31.12.2001. 3% out of total loan portfolio of this Bank corresponds to SME working capital, and 16% to SME investment capital, 7% was export financing, 8% were short-term loans, and 5% was agriculture financing. According to the type of industry 25% was granted to energy sector, 12% construction industry, 6% trade sector and 3% wood industry.


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IBF is also offering favorable terms for financing exports: ?? repayment period - up to 12 months ?? repayment modality – upon collection revolving ?? interest rate – EURIBOR for banks / EURIBOR + 3% for companies

Moreover, the IBF has an agriculture-financing program with the following terms: ?? repayment period: from 18 months up to 7 years ?? 6 month grace period ?? 4% interest rate for banks ?? 8% interest rate for final beneficiaries.

IBF’s typical terms for financing of SMEs programs of production are: ?? 24 months for financing of working capital ?? 36 months for financing of equipment ?? 48 months for financing purchase of business premises ?? grace period is 6 months ?? interest is EURIBOR for banks / EURIBOR +4% for companies.

Furthermore for the low risk bearing clients the IBF is granting loans in the amount of KM 2 mil. (1 – 5 years repayment) w ith interest rate EURIBOR+2%. Other banks are also supporting SMEs by offering them flexible repayment plan in accordance with cash flow and changeable interest rates, by offering products such as documentary collections, letters of credit, guarantees, etc. The International Community in BiH contributes a lot in strengthening the SME sector, as well. The World Bank, IFC, MIGA, and the global small business community is working towards creating new and better SME support programs.

3.9 Risk Coverage Several agencies offer insurance policies covering loan and investment risks.

3.9.1 MIGA (Multilateral Investment Guarantee Agency) Established in 1988 to encourage direct private foreign investment in developing countries - guarantees up to US$ 50 million against risks of transfer restrictions, war and civil disturbance, expropriation and breach of contract in the host country. It is also providing marketing services to the hosting government in the sense of enhancing its ability to attract foreign investors. MIGA offers long-term insurance against political risk to suitable investors for suitable investments in BIH. Participation of MIGA in the project instills trust that the rights of the investors will be respected.

3.9.2 IGA (Investment Guarantee Agency) Guarantees up to about US $ 1.7 million to foreign firms providing loans to Bosnian production companies. Its special risk fund within the World Bank guarantees against transfer restrictions, expropriation, import and export restrictions, and civil disturbances.

3.9.3 BH Export enterprises Facilitations (BEEF) Basic goals of BEEF are: ?? Providing working capital to companies capable of fulfilling export orders.


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?? Supporting self-sustainable economic growth by fringing and broadening export activities in BIH, which generates foreign exchange and speeds up the economic growth.

?? Supporting the development of private sector, since BH companies have to be private or in the initiating phase of the privatization to qualify for receiving funds from BEEF

?? Distributing information about BH banks to foreign banks. ?? Supporting high quality banks and facing with lack of funding in BH banking sector. ?? Distributing World Bank funds through foreign and local banks in the aim of

crediting exporters. World Bank funds are deposited in BH banks through IGA. ?? Strengthening relations between BH and foreign banks based on the sharing of risk

with foreign banks. ?? Decreasing of financing costs for BH companies.

3.9.4 OPIC (US Overseas Private Investment Corporation) Provides insurance for investors against political risk, expropriation of assets, damages due to political violence and currency convertibility, as well as insurance coverage for certain contracting, exporting, licensing and leasing transactions.

3.9.5 CEBiH (Export center for improvement of export and foreign investments)

Founder of the society is the Chamber of Economy of BiH and “Publikum” Ltd. Sarajevo. Limited Liability Company for improvement of export and foreign investments was founded in 1993. Activities of CEBIH are focused on the improvement of export of BiH economy, strengthening and establishing trade relations and promoting foreign investments in various economic activities. Along with these activities, CEBIH primarily works in connecting the BH economy and BH companies with foreign economies by ensuring the constant flow of market, commercial, technical, scientific and other information.

3.9.6 Foreign Investment Promotion Agency in BIH (FIPA) A governmental agency was founded in BiH in 1999 acting as a part of the Council of ministers (FIPA). Basic tasks of FIPA are providing services to current and potential investors, attracting new investments, promoting the country’s image, and the improvement of business environment in BiH. Key services provided by the FIPA are: ?? General promotion of investments, ??Mediation between local authorities and industry, ?? Investment services, ?? Help in choosing the most appropriate form of investments in establishing joint

ventures, ?? Help in choosing companies in the privatization process, ?? Providing detailed information on infrastructure investment projects, laws,

regulations, taxes and other duties.

3.10 Potential Market for Domestic Factoring As it was mentioned above there is a large number of underdeveloped SME businesses in BiH. Usually those are SMEs with not more than 9 employees. Hence due to overwhelming competition, it is very rare to obtain prepayments from buyers. Usually SME’s finance their receivables through banks, by obtaining expensive short-term loans for working capital, with the maximum repayment period of one year, and interest rates between 10% and 12%.


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As the business practice shows, buyers usually settle their payables within 30 to 150 days, except for few consumer goods such as alcoholic beverages where payments in advance or cash payment is performed. International and domestic retail chains like Mercator Slovenia, Interex France, Robot Commerce Croatia/BiH, VF Komerc BiH perform their payments to “brand” suppliers within 45 days. Contrary to this, payments to smaller suppliers (SMEs) are executed within a period of 120 to 150 days. Moreover, some invoices are settled through compensation. In the case of deferred payments the collection is secured by bills of exchange, or by bank guarantees or L/Cs, which are expensive (around 2.8% of the amount sold), and for that reason very rarely practiced. Due to the monopoly of some buyers, and high competition among sellers these security instruments are not executed often. By calling Bill of Exchange the bank account of a buyer can be blocked until payment is executed. However, this is usually not successful as buyers have several accounts with various banks. Buyers can be sued also, but court procedures in BiH take a very long period of time.

3.11 Market in other CEE countries The structural change in the BiH economy, focusing on the development of small and medium sized companies (SME's), offers a strategic window of opportunity for a factoring company, where traditional banks would appear to be: ?? over-estimating the risk levels in and ?? under-estimating the opportunities and chances ?? of the factoring business.

Especially small and micro clients have very limited financing options and their recurring needs for short term financing is a great possibility for factoring. For such clients factoring provides a clear competitive advantage versus traditional bank lending, as the factor is able to see a profitable opportunity where the banker can only see a risk. The development of factoring companies in CEE countries during and after the period of economic transformation is a clear confirmation of above indicated statement. As an example we describe the development of factoring companies in ?? Czech Republic ?? Hungary ?? Poland and ?? Slovenia.

Looking at figures relevant for factoring, the different size of the countries (e.g. Poland 38,5 Mio inhabitants - Slovenia less than 2 Mio inhabitants) as well as their different structure of economy and their different resources have to be considered.


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3.11.1 Czech Republic The very first factoring company in the former RGW countries -"Transfinance a.s.", Prague - was established in 1991 as a joint stock company with foreign participation. The shareholders were two factoring companies (Factofrance Heller and Intermarket Factoring AG), two banks (Bayrische Hypothekenbank and Zivnostenska Banka) and Transakta. Transakta - a Czech foreign trade organization - already had established in the early eighties a department for factoring and forfeiting (acting for Czech Exporters as an intermediary). Transfinance a.s. took over Transakta's business activities and developed them to international factoring standards. The factoring volume is shown on the tables below (purchased receivables):

Transfinance

0

50

100

150

200

250

300

350

91 92 93 94 95 96

in Mio USD

Total

Domestic

Transfinance

012

3

45

6

78

9

91 92 93 94 95 96

in Bill CZK

Total

Nowadays 5 factoring companies are offering their services to the Czech SME's. They reported a volume of purchased receivables of EUR 1.230 billion for the year 2001 and an increase to EUR 1.690 billion for the year 2002. All other factoring companies founded in the CEE counties within the last 12 years started their business from scratch. To be able to carry out international business all of the factoring companies entered one of the existing factoring chains: ?? Factors Chain International, Amsterdam or ?? International Factors Group, Brussels.

This is also recommended to an eventually established BiH Factoring company.


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3.11.2 Hungary Magyar Factor Rt., Budapest, Hungary, was established in 1992 as a joint venture between Magyar Hitel Bank Rt. and Intermarket Factoring AG. Both were shareholders with 50%. Business activities started in the second half of the year 1992, at the beginning focusing on export factoring using the two-factor-system of FCI. The factoring volume is shown below (purchased receivables):

Magyar Factor

0

5

10

15

20

25

30

35

40

92 93 94 95 96 97

in Mio USD

Total

Domestic

Magyar Factor

0

5

10

15

20

25

30

35

40

92 93 94 95 96 97

in Bill HUF

Total

Nowadays 11 factoring companies are offering their services to the Hungarian SME's. They reported a volume of purchased receivables of EUR 550 million for the year 2001 and an increase to EUR 577 for the year 2002. It must be mentioned that the biggest 4 cover 86% of the market, while the others are private owned factoring companies for special purposes.


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3.11.3 Slovenia LB Factors d.d., Ljubljana, Slovenia, was founded as a joint stock company in 1994. Shareholders were Ljubljanska Banka d.d., Ljubljana, 30%, IFC-International Finance Corporation, Washington D.C., 20% and Intermarket Factoring AG, Vienna, 50%. The company started with business activities in the second half of 1994, focusing on export factoring. Below see the annual purchased receivables:

LB Factors d.d.

0

5

10

15

20

25

30

93 94 95 96 97 98 99

in Mio USD

Total

Domestic

LB Factors

0500

1000

1500

20002500

3000

35004000

4500

93 94 95 96 97 98 99

in Bill SIT

Total

Nowadays 3 factoring companies are offering their services to the Slovenian SME's. They reported a volume of purchased receivables of EUR 115 million for the year 2001 and an increase to EUR 130 million for the year 2002.


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3.11.4 Poland Polfactor S.A., Warsaw, Poland, was established as a joint stock company in 1995. Shareholders representing 50% each are BRE Banks S.A., Warsaw, and Intermarket Factoring AG. Polfactor S.A. started the business activities in a different way as the other factors, concentrating on the domestic market. The factoring volumes see in the table below (purchased receivables):

Polfactor S.A.

02040

60

80100

120

140160

180

94 95 96 97 98 99

in Mio USD

Total

Domestic

Polfactor

0

100

200

300

400

500

600

700

800

94 95 96 97 98 99

in Mio PLN

Total

Nowadays 6 factoring companies are offering their services to the Polish SME's. They reported a volume of purchased receivables of EUR 3.330 billion for the year 2001 and a volume of EUR 3.249 billion for the year 2002.


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3.12 Recommendations ?? To establish a factoring firm, a preliminary permission must be obtained from the

Ministry of Finance or other competent institution. ?? Factoring Company should be established as a joint venture between local bank and

Intermarket Factoring AG, and perhaps IFC on the beginning (local bank 25%, Intermarket Factoring AG 55% and IFC 20%).

?? Since Law on Banks limits investments of banks in other companies, prior approval

of the Banking Agency must be obtained in order to permit investment of more than 5% of bank’s tier one capital. Note: Banks would not have no interest to invest since return on investment would be very low. The Banking Agency approval has to be obtained for at least 25% of investment in a factoring company. The other solution would be to amend the Law on Banks in that respect.

?? The factoring company shall start with export factoring, for which purpose it will

create a database of its exporting clients. ?? The agreement shall be made with each client in a way that all present and future

receivables from individual debtor or all debtors in that country shall be factored by established factoring company. In the case of domestic factoring, since higher risk is involved, receivables shall be assigned to the factor on the case-to-case basis, and recourse factoring policy shall be implemented.

?? Interest rates shall be competitive with bank’s interest rates.

?? Factoring fee shall range between 0.05% and 0.1% per day and shall be charged on

the 100% value of receivables. ?? The paid in share capital shall amount to KM 4.000.000,00 in order to become

member of Factors Chain International and to minimize risk of export factoring which would then stay on import factor.

?? The shares should be issued against cash. Shareholders must have the financial

resources to finance the capital subscriptions. ?? Factoring company may not issue letters of guarantee of any kind.

?? Factoring company shall not purchase receivables that are not substantiated by proper

invoices or other documents authenticating that such receivables have arisen from the sale of specific goods or services.

?? In order to ensure that the above-mentioned requirements continue to be met, all share

transfers and amendments to the articles of incorporation shall be subject to the approval of the controlling authorities.


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4 LEGAL ISSUES Prof. Miloš Trifkovic

4.1 Sources of Law Factoring industry in BH does not exist. Consequently there are no specific laws or regulations. That is why broader insight into sources of law and general legal environment is necessary.

4.1.1 International Sources International sources of law for factoring are not systematically included in BH international business law. BH is not a member state of International Factoring Convention, Ottawa, 28 May 1988). From autonomous acts o international business law two are especially important: The Rules of the International Factoring Association and The Rules of the International Factoring Chain. Other sources of international business law for factoring are present as in other contracts and transactions.

4.1.2 National Sources There is no specific law on factoring in BH. It does not mean that the legal framework is not existing. The acts listed and analyzed below are defining the legal space in which a factoring subject can successfully operate: ?? IPL Act (1984/1992, Sl. l. RBH 2/92), art. 18 – autonomy of the parties and Art 20:

collision norms; ?? Obligation Code (further: OC) from1969 ( Sl.l. RBiH 1992 and 29/03), especially ?? cession (art. 436 – 445), ?? sale, including the sale of rights (art. 454 – 551), ?? loan (art.557 – 556), ?? commission and Del credere com mission (art. 771 – 789), ?? credit (art. 1065 – 1068); ?? There is anew Draft of OC from 16.06.03. which is also favorable to factoring. ?? Company Law (“Zakon o privrednim društvima” Sl.n. FBiH 23/99. 29/03); ?? Banking Law (“Zakon o bankama” Sl.n. FBiH 39/98, 14/02). There is nothing in the

banking law that forbids or could forbid factoring as a special branch of activity; ?? Companies’ Registration Act (Sl.n. FBiH 4/2000; Uredba u Sl.n. 12/00 i 23/00 –

CRA); ?? Central Bank Act (Sl. gl. BiH 1/97); ?? Bankruptcy Act (Sl.n. FBiH 29/03; hereinafter - BA); this new piece of legislation

offers good opportunities to factor; ?? Liquidation Act ((Sl.n.FBiH 29/03) ?? Foreign trade laws and regulations which are very stabile ?? Other general acts


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There is no specific regulation for “financial organizations” that may include factoring subjects. Art. 21. Para.3. of the Regulation on Registration of Business Subjects as “financial organizations” considers only depositary subjects.

4.2 Subjects

4.2.1 Types Potential subjects of factoring can be registered in either BH Entity. The most suitable subjects are following. Banks are a possible status law form in the very beginning of the industry. There are no systematic barriers in banking law that prevent banks from performing factoring activities. The problem I different business philosophy: banks are oriented towards the borrower, factoring companies both towards the borrower and his client. Bank as a founder of the factoring company has some limitations. Banking Act limits bank’s investments into other companies, including factoring ones. A bank’s share equity share is in a financial organizations limited to 50%, and to 25% in no-financial ones. That is why a specific factoring law should explicitly declare factoring companies as financial organizations. Though banks in BH have sufficient capital it would be unwise to allow them to have 50% of equity in factoring firms. Limited companies (art. 309 – 374 Company Act) are the most probable type of subjects in the beginning of the factoring industry. Reasons are following: minimal equity capital 10.000 KM, fast to establish, no special state agency control, simple management, relatively cheap book-keeping and financial control, possibility of keeping it as a closed corporation, relatively simple liquidation. A specific factoring law should raise the initial capital minimum form 10. 000 KM to the higher level, in accordance with estimated needs of this industry. Joint stock companies (art. 107 – 308 Company Act) might be a suitable form for factoring firm in the latter phase. Reasons are: minimal equity capital 50.000 KM, relatively long procedure of establishment and entering into the court register, two administrative state agencies involved in the approval of shares and registering of shareholders, complicated internal structure, expensive auditing, undeveloped stock exchange, long liquidation process. It is important to emphasize that 2003 amendments of the Companies’ Act have considerable improved transparency in business dealings of firms. Changes in registration, letterheads, mergers and dissolutions will help factor to estimate risks much easier.

4.2.2 Business Activity According to art. 39. of Banking Law, banks can perform the following activities relevant for factoring: Financing function: lending Financial management services: ledgering, collection of receivables; Protection against default by debtors: providing for all sorts of financial warranties, including del credere protection against default.


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If factoring is the core business of a bank or a company, the above basic functions can be performed within the existing legal system. For the registration of financing function sees the following numbers in the Standardized Classification of Activities in FBH (Sl.n. FBiH 28/98), starting with: “J”: 66.2 “Other financial brokerage”, except that performed by banks; 65.2265.2220: “Other credit businesses regulated by specific enactments”; 65.2365.230: “Other financial brokerage, not mentioned elsewhere”. In addition, international factoring requires special registration for foreign trade. Signatures of the persons authorized to represent the company in dealings with foreign partners must be deposited with the court register.

4.2.3 Registration Requirements: The factoring company has to be registered with courts in the Entities, including publication in the appropriate official gazette (art. 55 CRA). For domestic factoring there are no specific rules. The factoring company will be registered like any other company in BH. If the factoring company is to engage in foreign trade, there are additional registration requirements. Such a company has to meet internal and external conditions. The internal ones are specified by company bylaws, which must: ?? Explicitly list foreign trade as one of the activities; ?? List foreign trade tasks and activities; ?? List officer positions dedicated to foreign trade; ?? Contain conditions, which employees in foreign trade must fulfill. ?? External requirements to be fulfilled during registration: ?? The above-mentioned bylaws must be deposited in the court register, as well as ?? Officially verified signatures of persons empowered to represent the company in

foreign trade. Other registrations required: ?? Entity Bureau of Statistics; ?? Tax register; ?? Customs, especially if the factor performs marketing functions or if the reservation of

title clause exist in the contract of sale; ?? Banking agencies of the Entities keeping bank registers (art. 16 Banking Act); ?? Central Bank, if it is going to take over supervision of the factoring industry,

In spite of numerous registrations, a central register of companies and other business entities does not exist either on the Entities’ or the State level. Some preparatory work in introducing a central register are underway-

4.3 Shareholders There are no specific shareholding requirements on factoring companies . General requirements and limitations of shareholders’ position applicable to factoring are listed bellow: ?? Differences between the positions of shareholders in limited (in Bosnian: “d.o.o.”)

and joint stock companies (in Bosnian: “d.d.) exist, but not in respect of liability for acts of the company;

?? Art. 6. of Companies Act provides for four cases in which the shareholder(s) is/are severally or jointly liable for the liabilities and debts of the company:


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o If the shareholder uses assets of the company for personal goals which are different from the goals of other shareholders;

o Manages the assets of the company as if the company assets were his/her own property;

o Uses the company as an instrument of fraud or in order to damage his/her personal creditors;

o Influences the company to decrease capital in favor of third persons or to take on obligations, which the company will not be able to fulfill.

Connected companies (Companies Act, art. 45 -50) are two legally independent subjects inter-related by capital and management. Their relations must be regulated by contract. Though the legal phrasing is not precise, the intent of the law is clear: the “contract” must be a management contract, not an agreement to invest into equity. Managing Subject is called “Majority Company” and the managed one “Subsidiary”. Majority Company is unlimitedly and jointly liable for the obligations of Subsidiary, if the subsidiary acted in accordance with binding instructions of the Majority Company. If shareholders of the Subsidiary have suffered loss due to the instructions of the Majority Company, they are entitled to sue the Majority Company for damages. Bankruptcy creditors of the Subsidiary have the same right. Art. 22 of Banking Act limits a bank’s investment into company equity. 22 This limitation applies to the bank’s investment in factoring companies, too. Briefly: ?? without prior approval of the Banking Agency, a bank is not allowed to have a

considerable direct or indirect equity interest in a joint stock company capital exceeds 5% of the bank’s equity capital;

?? without prior approval of the Banking Agency, total net value the bank’s interest in other companies can not be higher than 20% of the bank’s equity capital;

?? in any case, the bank is not allowed to have a stake in one company which exceeds 15% of bank’s capital, and its total shareholdings in different companies may not be bigger than 60% percent of bank’s equity capital.

4.4 Insolvency Regulation

4.4.1 Insolvency Insolvency is the reason for the initiation of bankruptcy procedure. According to Art. 6 of BA, insolvency occurs if a debtor is continuously incapable of paying his/hers matured pecuniary debts during 30 (calendar) days. An occasional payment to some creditors does not constitute a breach of insolvency period. Insolvency also exists in the cases of future foreseeable incapacity to pay debts as they mature. In this case only the debtor can filet he bankruptcy procedure. For the sake of creditors’ protections, banks are obliged to regularly publish a list of their insolvent clients in its Entity’s official gazette. They are classified by the duration of insolvency: 15 -29 days, 30 – 90 days and longer than 90 days. The first Bosnian credit bureau “LRC”) has recently been established (“Oslobodenje” 08.12.2002). Its main activity is providing private clients with information on solvency and creditworthiness of their business partners.


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4.4.2 Bankruptcy At the beginning of July 2003 bankruptcy law has been radically changed (Sl. n. FBH 29/06). The La w is drafted after German model. Generally, changes are favorable to the factor: ?? General manager must file for bankruptcy if insolvency lasts longer than 30 days, or

if he/she can foreseen future insolvency; ?? Insolvent debtor must cooperate in the bankruptcy procedure; ?? Interim official receiver acts in preliminary bankruptcy proceeding in order to protect

bankruptcy estate; ?? Bankruptcy judicial panel is abolished, only the bankruptcy judge remained as the

official of the court; ?? Bankruptcy procedure is accelerated; ?? Creditors have mush more influence on the proceedings; besides board of creditors,

BA introduces a new body: assembly of creditors; ?? The state does not any longer enjoys priority rights over business creditors ?? Objects not belonging to the debtor can be exempted from the bankruptcy assets. Oof

the cases is reservation/retention of ownership title made by other person. Pctum reservati dominii suffices for the extraction of the objects from bankruptcy assets (art. 81);

?? The order of payment from bankruptcy assets is: ?? expenses of the bankruptcy procedure: court taxes, bankruptcy bodies’ and manager’s

compensation; ?? debts from business dealings made by official receivers after the opening of the

procedure, if they could not be paid during their activities; ?? employees’ salaries and labor accident damages ?? general bankruptcy creditors, including factors and ?? lower ranked bankruptcy creditors.

Chapter “V Reorganization” is the greatest and for the factor most important change in bankruptcy law. Basic idea behind the new regulation is that the insolvent debtor should not necessarily be erased form business and legal life. In accordance with “insolvency plan”, i.e. the plan of reorganization, wide range of business arrangements is possible in order to keep insolvent debtor going. Factor can actively participate in them and so preserves his or his client’s rights in insolvency proceedings.

4.4.3 Liquidation The Law on Liquidation appeared in the same time as bankruptcy legislation (Sl.n. FBH 29/3). It is simpler than pervious one. For the factoring is essential that the new Law retains control of the courts over liquidation proceedings and that direct protection of creditors is the responsibility of liquidator. The court appoint liquidator, who may be general manager of the company to be liquidated

4.5 Civil and Business Law Framework

4.5.1 Obligation Code and its New Draft The main source of this branch of law is the relatively modern Obligation Code (OC). It contains general rules on obligations, contracts and damages, which are directly or by


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interpretation largely applicable to factoring. In the amendment of OC (Off. Gaz. 29/03) there is a new legal presumption that unpaid dues interest are assigned together with the main debt. The new OC Draft appeared in June 2003. It includes some new contracts, but does not nominate factoring as a nominated civil law contract. Yet, there are several important new provisions in the OC Draft relevant for factoring: ?? Electronic orders (art. 33); ?? Contractual clause forbidding assignment of claim is not valid in business contracts

(art. 543); ?? Contractual interest rate regulation contains broader and more specific solutions on

this issue (art. 498-499); ?? The OC Draft differentiate between loan transactions, and the regulation is much

more specific and modern. Regulation of other issues remains practically the same as in existing Obligation code.

4.5.2 Pecuniary Obligations Specific regulation for pecuniary obligations exists in OC (art. 394 – 402 and 277 – 279) for interest of arrears. Special Law on Interests on Overdue Payment is in force (Sl.n. FBH 27/98 and 51/01). No interest is due on advance payments in BH; stipulation to the contrary is allowed. Advanced payment in general is not considered a loan, so that factors could use it to accomplish their financing function. OC amendment ( BH Off. Gaz. 29/03) introduces simple presumption that matured outstanding interests are automatically transferred with the main debt. Assignee has the duty to up to date public registers concerning assignment, if there is no stipulation to the country.

4.5.3 Contract Making OC contains appropriate contract-making rules (art. 26 – 83 OC). They cover contracts and option contracts. The main principle of OC is that the contracts are informal. It does not suits the needs of factoring. That is why factor should insist on contract in writing. Its general conditions of dealing could contain such a clause. Protecting the customers, existing OC regulates general conditions of dealing. In the OC draft it is not a case. That is why factor should carefully a accommodate their general conditions to Consumers protection Law. It is also recommendable to insert into the contract of general condition a clause expressly saying the factoring contract is being regulated by the IFC.

4.5.4 Cession Cession is the main contractual vehicle for assignment of receivables. It can be affected independently or within the transfer of the contract as a whole. Arts. 436 – 445 OC are posing lesser obstacles to factoring than some older civil law codifications (Code civil, BGB, Codice civile). In spite of that, there are some barriers to overcome.

4.5.5 Critical Points for Factoring in OC Critical points in OC regulation from the point of view of factoring: ?? Claims, which are impossible to assign: those forbidden by law, strictly personal

claims and “claims which are not assignable due to their nature” (art. 436.1 OC). The last type could give rise to interpretation disputes in factoring;

?? Assignment of claim can be excluded by contract, either unconditionally, or under the condition of the debtor’s consent (art. 436, 2 OC). This is contrary to Art. 6.1. IFC. Exclusion of right to assign is not often used in business practice;


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?? The debtor must be notified of the assignment, but his/her approval of the assignment is not necessary (art.438 OC). Any form of notice and any procedure is legally correct, so usual factoring practices will be valid in BH too;

?? Art. 436.1 OC, mentions “claim” only in the singular; grammatically, its wording comprises only the existing claim. Case law and theory are unanimous that all claims, even natural ones (obligatio naturalis) , existing and future, can be assigned if other conditions are satisfied. According to the same sources, claims can be assigned either individually or globally ;

?? Assignment can relate to the claim as a whole or to its part, if legally and practically feasible. In the latter case, the assignor must transfer the document proving the existence of the partially transferred claim (art. 441, 2 OC). According to theory, partial assignment is not usual in factoring practice. So, art. 441. 2 can be ignored in the factoring industry;

?? Assignor guarantees to the assignee that account receivables exist at the moment of cession if the assignment is made against payment (art. 442 OC). This provision can be fully and without problems applied in factoring. Mandatory provision of art. 443 OC is not directly applicable to all forms of factoring. According to it, the assignor guarantees the possibility of collection of ac count receivables only if so explicitly stipulated in the contract, and to the extent of the sum received by the assignor. Stipulation to the contrary is null and void. This solution isn’t factoring friendly and should be replaced in specific factoring legislation;

?? If the same account receivables are assigned to several assignees, the priority belongs to the assignee that first informed the debtor of the assignment (art. 439 OC);

?? Interpretation of art. 436. OC makes the assignee the master of the claim. That is why he/she can lawfully transfer it to any third party. There are no mandatory law limitations on the number of further transfers ;

?? Collateral rights, including securities, automatically pass to the assignee with future receivables (art. 437. OC). Contrary to Art. 7. IFC, OC does not provide for transfer of the title reservation right to the factor. In OC art. 540 – 541 sale contract with reservation of title (pactum reservati dominii) is regulated as a specific type of sale contract. The approach to this sort of sale is very conservative and not suitable for factoring purposes. Retention clause is valid against third persons only if it is enshrined in the deed, made before bankruptcy or seizure. If there is a lien registry for movables, the retention clause must be entered into the registry;

?? Possible grounds of debtor’s defense in BH law (art.440 OC) are the same as in Art. 9 IFC. To protect the legal position of the assignee against the debtor, art. 441 OC introduces the legal obligation of the assignor to transfer to the assignee not only the receivables, but also proof of main and ancillary rights.

4.6 Lending and Credit Contracts Besides advance payment, financing function of the factor includes “loans”. In BH law the concept of money lending is divided into two types: ?? Loan contracts (art. 557 – 566 OC) ?? Credit contracts ( art. 1065 – 1068 OC).

Amendment of the Property Law (Off.Gaz. 29/03) is extremely important for secured loans. The consent of mortgage debtor is no loner precondition of transfer of mortgage from the old to the new creditor. This makes legal position of the factor much more safe and stronger. OC Draft does not enlarge numbers of credit types, but its regulation of banking business is much more complex and modern. Loan contracts belong by nature both to civil and business law. Any person and any type of goods, including money, can be the subject matter of the contract. The contract need not be in


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written form to enter into force. In business loan contracts interest is a natural element of the agreement (art.558). The regulation is optional and very broad, so it can easily accommodate the needs of factoring companies. If the factoring company acts under the “loan contract regime”, there are no legal restrictions on lending. In a credit contract, only a bank can be the creditor. The same is stated in art. 39 of the Banking Act. Money is the only subject matter of the contract, interest is essentialia negotii and the contract must be in writing. Besides that, a huge body of mandatory law regulates the banking business, including extension of credit and credit “exposure” of a bank (art. 42 of Banking Act). In the implementation of the aforementioned rules, Federal Banking Agency (Sl.n. FBiH 9/96, 27/98, 20/00, 45/00) has passed at least six regulations. By controlling banking agencies in two Entities, the Central Bank is controlling credit policies and practices of banks in BH. If a bank is going to engage in factoring business, all of the rules stated above, should be applied strictly. (Q: v). According to art. 42. of the Banking Act, credit risk exposure of a bank can not exceed: ?? for one client : 5% of the bank’s equity capital if the credit is not secured; ?? for one client or a group of “connected companies/lenders”: 25% of the bank’s equity

capital if the credit is properly secured; ?? 300% of the bank’s equity capital in any case.

4.6.1 Interest Rates There are two essential pieces of legislation concerning interest rates in the factoring industry. The first one is OC. OC Draft enlarges number of articled dedicated to interest rates, and they should be carefully examined by factors. OC Arts. 399 – 402 are stating general rules. The second group of provisions is in arts. 277 – 279, that regulate interests on arrears. Mandatory law regulates default interest on overdue payment in business transactions (Sl.n. FBiH 27/98 and 51/01). Currently, the interest rate on arrears is 12% on a yearly basis, calculated by “konformni nacin obracuna” - “conform method”/ “equivalent method”. Relation between two acts deserves some remarks: ?? If the parties in a business transaction do not stipulate the interest rate by contract, it

amounts to 8 % a year, and the payment is due after the end of the year , as long as the parties do not agree to the contrary. Higher interest rates can’t be stipulated (art. 399, 3 and 4. OC).

?? Compound interest is not allowed, but the parties can agree on a higher interest rate after the debtor’s default payment (art. 400, 2. OC). After the amount of interest due is transformed from ancillary to main debt by court action, a simple interest rate can be charged on it. It is very important that point 3 of art. 400 OC excludes the application of the aforementioned rules to credits given by banks “and other baking organizations”. This is one of the main reasons for the formal status law classification of factoring companies as “financial” and/or “baking” organizations. The interest rate on overdue payments is set by a mandatory law act to 12%. In this respect the OC allows some contractual modifications. If the contractual interest rate is higher than 12%, it supersedes the one set by law.

4.6.2 Collection of Receivables Both BH entities accepted the former SFRY Law on Execution Procedure (Sl.n.FBiH 2/92, Sl. gl. RS 17/93 and 14/94 – further on: LEP). It contains the usual and detailed continental law regulation. The law needs re-drafting in order to make it fully compatible with institutional changes in BH state and economy. FBH recently passed the new Law on Executive Procedure (32/03) Some of the provisions are particularly important for factoring. ?? Creditor, i.e. factor, starts the procedure in the municipal court. Enforced performance

titles are: final court decision, judicial settlement, final administrative act, final notaries’ act and other similar deeds created in BH (art. 16. LEP, art. 23 FBH LEP). If


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there are more pecuniary creditors, the creditor who got the enforced performance title first has priority (prior tempore, potior iure).

?? Enforced performance on money assets in bank accounts is specially regulated in Articles 194 – 209 LEP and art. 166 – 176 FBH LEP. By interpretation, the Service of Social Bookkeeping (SDK) is replaced with the bank in which the debtor has KM and/or foreign currency accounts (arts. 206. and 208. LEP). The execution is performed by court order to the bank to transfer the sum due from the account of the debtor to the account of the creditor, without any limitation (art. 195. LEP, art. 166 GFBH LEP). The creditor whose execution title the bank has received first has priority (art. 197LEP, art. 167 FBH LEP). If the debtor’s accounts are empty, the bank is not allowed to execute the debtor’s payment orders before transferring money to the creditors. In this case, creditors have the right of execution on other assets of the debtor (art. 202. LEP). Bank must inform the court that there is no money on debtor’s accounts (art. 169 FBH LEP)

Research in cantonal and municipal courts in Sarajevo gave the following results. The execution procedure lasts at most ten days after the court office has received the execution request. The average time is three days: two for assembling the file, and one for the judge to pass the decision based on the execution title. The courts don’t have sufficient feed-back on what happens with their execution decisions. Despite that, the courts are sure there are some problems within the banks. Very often banks are not prone to transfer money immediately, so creditors have to turn to the court office for repeated interventions, including submission for criminal investigation to the public prosecutor’s office. That is probably why lawyers and practitioners consider execution on accounts in thirty days a pretty good outcome. The new FBH LEP orders urgent executive procedure in all cases ( art. 5)

4.6.3 Guarantee Contracts Protection against default in payment for the factor really means he/she must give to the client surety that the receivable shall be paid, if not by the debtor, than by the factor himself/herself. This result can be achieved in BH law by two main vehicles: guarantee contract and agency (commission) contract. Arts. 997 – 1019 OC contain norms on guarantee contracts. Generally speaking, this regulation is factoring-friendly. Still, we must underline several regulations in OC which are very important for factoring industry in BH: ?? The contract must be in writing( art. 998); ?? Guarantee can be given for conditional and future obligations (art. 1001, 2. OC); ?? Guarantee may be given for an already existing guarantor (art. 1001. 4 OC); ?? Guarantor’s duty can not be bigger than the debtor’s (art. 1002 OC); ?? Guarantors in business transactions are always jointly liable with the debtor (art.

1004, 3. OC); ?? Legal regime of debtor’s objections suits needs of factoring (art. 1009).

4.6.4 Commission Contract Arts. 771 – 789 OC regulate commission contracts in the continental law manner. The essence is that the commissioner in the market acts in his own name, but on behalf of his client. Though OC mostly contains rules on the commission for sale, it can be used like a legal template for different businesses, including factoring. OC enables both closed and disclosed commission, which makes it similar to common law agency. That is why domestic BH legislation does not impose special obstacles for the development of factoring industry. In factoring construction, the commissioner can appear as either client or factor. In both cases del credere relation is possible. For additional provision del credere commissioner is jointly


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liable with the debtor (art. 781 OC). Del credere commission will appear in non-recourse factoring.

4.7 Foreign Trade and Exchange Law Framework

4.7.1 Foreign Trade System of BH Foreign exchange system and law in BH are reflecting the Dayton structure of the BH state (further on: State). Trade, custom and monetary policies are competencies of the State. The Ministry of Foreign Trade and Economic Relations of BH perform them. The implementation of policies is the responsibility of the Entities (Art. III 1.of BH Constitution). In FBH there is a Ministry of Trade and in RS the Ministry for Trade and Economic Relations with Foreign Countries. The level of the State control over legislative and practical implementation varies from one policy to another and from sector to sector. State’s and Entities’ laws regulate activities of foreign physical and legal persons in BH, and the business dealings of BH legal persons abroad. They encompass all types of foreign transaction in goods and services, including factoring. The essential feature of this regulation is liberalism (Q: vi).

4.7.2 Factoring as a Service In Art. 23. of the State Law on Foreign Trade Policy (Sl.gl. BH 7/98; further on – LFTP) and in Art. 27. of the federal Law on Foreign Trade Business (Sl.n. FBH 2/95; further on: FTB), factoring is among the service industries. In LFTP, international trade in services is regulated in accordance with WTO standards set forth in GATS (Arts. 23 – 25 LFTP). Service activities in BH are taxable. If exported, there is no 10% service tax duty on invoice value. Council of Ministers and governments of the Entities can impose special conditions for some services performed by foreign legal persons in BH. According to Art. 27 LFTP they include: ?? Reciprocity between BH and home state of the foreign company; ?? Establishment of own or joint venture company registered in BH; ?? Formation of cooperation contract with domestic legal person ?? Registered for the type of service in question and ?? Employment of locals in prescribed ratio.

4.7.3 Foreign Exchange Regulation The State of BH exercises its prerogatives in monetary policy through the Central Bank. Art. 1. of the Law on Central Bank (Sl. gl. BH 1/97) prescribes that the Central Bank acts exclusively as a currency board with the primary task of preserving the value of the domestic currency (art. 2). The fact that the Central Bank has performed its duties well essentially influences foreign exchange regime relevant for factoring. The main act in foreign exchange regime is the Law on Foreign Currency Operations (Sl.n. FBiH 35/98; further on – LFCO). Its salient characteristics relevant for factoring are: ?? Acquisition of, and disposal with foreign currency is very liberal (Art. 23 – 34

LFCO); ?? Foreign exchange market is regulated (Art. 10 -22) and in function; ?? Foreign currency payment abroad must be performed by banks (Art. 7); ?? All payments stemming from foreign exchange transactions with foreign partners are

free (art. 8) ; ?? A BH subject is obliged to collect receivables from abroad within 90 days after the

export of goods or services. On request, the Ministry of Finance can extend this


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period once, but for no longer than 60 days (Art. 38). The aforementioned terms are relevant in the case of factoring too. The fine for infraction of this duty is between 5000 and 25000 KM;

?? In sales on credit, collection of receivables must be performed within 90 days after credit expiry, and can be extended once, but not longer than 60 days (Art. 38). ). The aforementioned terms are relevant in the case of factoring as well. Fine is the same as in non-credit transactions: 5000 – 25000 KM.;

?? compensation agreements with foreign partners are subject to prior approval by the Ministry of Finance. The date of approval is considered as the date of collection (Art.36);

?? Exchange control is vested in the Ministry of Finance (Art. 60).

4.7.4 Foreign Direct Investment Foreign direct investments (further on: FDI) are part of the foreign trade regime (Art. 10 LFP). State Law on FDI Policy (Sl.gl. BH 17/98; further on - LFDIP) is regulating this field. The regime of LFDIP closely follows WB “Guidelines on the Treatment of Foreign Investments”. Besides, FBH passed the Law on Foreign Investments (Sl.n. FBH 61/01: further on: - LFI) and RS the Law on Foreign Investments and Concessions. Those two acts extend, rather than deviate from SLFDI. Highlights of LFDIP for the foreign investor willing to establish own or joint venture factoring company in BH are: ?? at the moment, investment in factoring business is possible without limitations

(Art.3); ?? investment requires no approval (art.4); registration in ministries is only for the

purposes of statistics; ?? national treatment is guaranteed by the FLDIP; Most Favored Nation (MFN) clause is

in force if inserted in BITs; ?? the FLDIP and BH legislation generally are granting moderate but very important

benefits to foreign investors; ?? custom benefits are applicable to equipment which is less than 10 years old,

compatible with the activity of the business venture and conforming to BH standards. An additional condition is that the investment amounts to over 30% of the company’s equity capital;

?? tax benefits are granted if the investment is higher than 20% of equity capital. Tax benefit is proportional to the ratio of domestic and foreign capital in equity and it is extended over 5 years ;

?? stabilization clause is favorable to foreign investor and has no time limit (Art. 20). It is extremely important because BH legal system is in transition.

4.8 Recommendations

4.8.1 Policy Recommendations for Future BH Legislation ?? Create government factoring policy; ?? Ratify IFC; ?? Pass state Law on Factoring that will reflect IFC and recent changes in BH

legislation; ?? BH Law on factoring should amend existing legislation and fill lacunae in order to

make legal regime factoring friendly.


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4.8.2 Legislative Recommendations ?? In the new state Factoring Law identify factoring as a financial service; ?? Allow factors to extend bank-type credits to their clients; ?? Regulate relations between banks and factors, especially in equity issues; ?? Do not establish factoring companies as subsidiaries of banks; ?? Submit factor to Central Bank oversight; ?? Suggest limited liability company type as the preferred form for a new factoring

business; ?? Analyze in detail impact of the new Bankruptcy Act on factoring; ?? In the new Factoring Law correct insufficiencies of the Obligation Code from the

standpoint of factoring.

4.8.3 Technical Recommendations for the New Factoring Law ??Mandate written form of factoring contact; ?? Regulate scope and validity of general conditions for factoring contracts; ?? Expressly declare that debtors consent is not a precondition for validity of assignment

of claims, as long as factoring contract between creditor/client and factor exists; ?? Explicitly regulate that future and determinable claims are assignable both

individually and generally; ?? Introduce simple presumption of assignor guarantee for possibility of collection of

accounts as soon as factoring contract comes into force; ?? Provide for clients liability to factor for all expenses and costs factor had, even if they

are higher than first payment made to the client (70% - 90%); ?? Regulate sale contract with reservation of title (Pactum reservati dominii) in

accordance with Art. 7 IFC. It asks for explicit derogation of Art. 540 – 541 OC, or ?? Art. 657 – 658 OC Draft); ?? Harmonize Factoring Law with IFC wherever it is possible; ??Mandate the establishment of a factors’ association as a self regulatory body.


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5 ACCOUNTING AND TAX ISSUES Mahir Džafic

5.1 Tax System in BH and Factoring

5.1.1 Fiscal Entities Fiscal entities – Federation of BiH, Republika Srpska and the Brcko District. Practically, in BiH there coexist three tax systems, which is a result of giving fiscal independence to the Entities and the Brcko District. Therefore, all explanations that follow related to the treatment of factoring and influence of different tax solutions (sales tax and income tax) to factoring are related to individual fiscal entities.

5.1.2 Brief Overview of the Current Situation Following the Dayton peace accords, the entities have become responsible for fiscal policy and creating the tax system, and they adopted their own Laws on Sales Tax. The system of the sales tax was taken over from the former SFRY. It has been changed and supplemented in the course of time. Until recently, there were two, because the Brcko District used to apply the law of the Republika Srpska. All three fiscal entities apply a single-phase sales tax in three versions. Yet, one should emphasize that those are almost identical laws/solutions, with only few differences, primarily related to specifying the products and services that are exempt from taxes. Not so long ago (early 2001) IMF developed a study on introduction of VAT in BiH, and the political encouragement to introduction of the VAT at the state level was given by the High Representative. One can expect that the indirect taxation in BiH will be arranged uniformly with introduction of the VAT, and there are some announcement that this will happen by 2005. Direct taxes are also at the entity level. Currently, there are two entity laws regulating the corporate income tax of companies in three fiscal entities because Brcko District applies the Law on Company income tax of the Federation BiH. The Republika Srpska has recently adopted a new Law on Company Income Tax, with the intention to broaden the tax basis. That would justify the reduction of the tax rate from 30% to 10%, with fewer possibilities to reduce the tax liabilities. There were also some changes in the Republika Srpska with respect to direct taxation of citizens, and new Law on Income Tax was adopted. In the Federation BiH, the Law on Company Income Tax adopted in late 1997 is still in force, which prescribes the 30% taxation rate and broad possibilities of reducing the tax basis. The preparations for changing the Law, or more precisely, for introduction of a new Law, are currently ongoing. Those activities are running simultaneously with reform (preparation of laws) in the area of taxation of the income of the citizens in the Federation of BiH, which is lead by the GTZ, that is preparing the legal provisions together with national experts.

5.1.3 Sources of Law As already said above in the introduction, there is a tax framework which would affect factoring itself as a service and also the company that would be performing this activity, and the companies that would use this type of service too. Those are: Federation BiH Law on Sales Tax (“Official Gazette of FBiH”, No. 49/02 – clarified text) Rulebook on implementation of the Law on Company Income Tax (“Official Gazette of FBiH”, No.53/02 – clarified text) Law on Company Income Tax (“Official Gazette of FBIH”, No. 32a/97, 29/00)


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Rulebook on Implementation of the Law on Company Income Tax (“Official Gazette of FBiH”, No.31/98, 36/98, 4/01) Republika Srpska Law on Sales Tax (“Official Gazette of RS”, No. 25/02 and 30/02) Rulebook on Implementation of the Law on Company Income Tax (“Official Gazette”, No. 65/02) Law on Company Income Tax ("Official Gazette”, No. 51/01) Rulebook on implementation of the Law on Company Income Tax (“Official Gazette”, No. 70/01) Brcko District Law on Sales Tax (“Official Gazette of the Brcko District”, No. 07/02) In the area of company income taxes, applied is the Law on Company Income Tax (“Official Gazette FBiH”, No. 32a/97, 29/00) For the purpose of achieving completeness of the text, we shall consider factoring from the aspect of the income tax (factoring firm as a payer of the income tax and effect of the factoring service to the tax liabilities of the client) and from the aspect of the sales tax (factoring as a business transaction-service).

5.2 Company Income Tax

5.2.1 Federation BiH Corporations having their seat in FBH must submit tax application for the corporate income by the end of March of the current year for the previous fiscal year. The resolution on the amount of tax liability has to be made to the Tax Administration not later than June 30th6. Procedure of tax duty determination is following: ?? The initial amount is the amount of profit (loss) from the income statement, which is

made on the basis of accounting regulations and standards; ?? after that, the possible expenditures not recognized for the purposes of taxation are

determined, i.e. exempting them in the sense of taxation; ?? the profit/loss is increased for the determined expenditures not recognized for the

purposes of taxation, which defines the “taxable profit” (profit in accordance with accounting standards + possible expenditures not recognized for the purposes of taxation)

?? taxable profit is reduced by possible transferred (not used) tax losses from the previous five years 7

?? the rest is the basis for calculation of the income tax for the given year, which gives the calculated tax (by applying the 30% tax rate);

?? to the amount of calculated taxes, fiscal authortiy is applying the prescribed possible exemptions or reductions of the tax liabilities.

?? In the rest of this text we will cover different points from the above-explained scheme (sequence) of which we believe that they have or may have influence on the operation of the factoring firm and the clients.

Determining the Expenditures not Recognized for the Purposes of Taxation in FBH For factoring activity, certainly the most interesting is the description of receivables: “Expenditures caused on the basis of write off of receivables are recognized in terms of taxation only if all legal possibilities of collection (warning, lawsuit, request for execution) have been exhausted” (Article 4, paragraph 3 of the Rulebook). 6 Very often, this deadline prescribed by Law is not respected, i.e. the Tax Administrations are late with those resolutions. 7 It is allowed to use tax losses not older than five years


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Therefore, in order for expenditures on the basis of write off of receivables to be allowed in terms of taxation, it is necessary to file a lawsuit against the debtor. Any non-sued receivable, which has been written off, increases the taxable profits.8 The same position is applied by the tax agencies in FBiH. Sales of receivables as such do not affect the tax balance. In case of inability to collect the receivables and possible write off of receivables, the factor would have to take into consideration the tax treatment. If the write off were done without suing for receivables, the write off would increase the taxable profits. All ambiguities related to this issue could be removed by changing the Rulebook on Implementation of Law. Ministry of Finances should delete the obligation of suing for the receivables for the purpose of recognizing the write-off in taxation. Other Relevant Aspects of the Income Taxes in FBH Although not unique for the factoring activity/company, and for the purpose of presenting the tax treatment of the businesses in different fiscal entities in BiH, the remaining text contains the explanation of possibilities to reduce the tax basis. After having determined taxable profits, there is a possibility to reduce the tax basis for the losses determined under the preceding tax balance, up to five previous years. The amount determined in this way is considered as tax basis on which the tax rate of 30% is applied. This then gives the newly calculated amount of taxes. The law foresees broad possibilities of reducing the calculated income tax, not as reduction of tax basis, but as direct reduction of calculated tax. Exemptions are the following: ?? Newly established commercial company is exempted from paying the income tax, in

the amount of 100% for the 1st year, 70% of the income tax in the second year, and 30% of income tax for the third year.

?? Investment of foreign capital: in case of a commercial company where foreign persons have invested capital or which were founded (i) by foreign capital, under condition that the share of foreign capital is at least 20%, the income tax is reduced proportionally to the share of foreign capital in the total capital, for the period of five years from the investment made. According to the interpretation provided by the Ministry of Finances, the subsequent investment, after the lapse of five years, do not entail the similar tax benefits;

?? Investments (reinvesting profits).

If a commercial company makes a decision (and a promise) to reinvest the profits into fixed assets in the next business year, it is entitled to reduce the calculated income tax by the amount of the promised investment, up to the amount of calculated tax. The percentage of reduction depends on the purpose of investment: in case of investing in productive activity, a 100% reduction is possible; in case of investing in non-productive activities –reduction in the amount of 75% of calculated taxes is possible; in case of investing in apartment building – 100% reduction. Such investments will have to be made by the next tax application, and evidence to that respect has to be submitted9. Otherwise, the reduced tax will have to be paid, together with one-year interest (0.06% per day). It is important to say that the application of all described tax reduction is cumulative. Each basis for reduction is used individually and separately, on its own, and none of them excludes nor reduces the others. For instance, in case of a joint venture between a foreign factoring company and a domestic bank, where the respective shares are 60:40, and without using the possibility to reduce taxes using the provisions applying to reinvestment, the tax liabilities in the next five years would be: 8 As a consequence of this, the companies from FBiH are not eager to make corrections of the value of receivables, because that exposes them to court expenditures, so in most cases, the accounting values of this part of property are over estimated.. 9 There are significant problems related to recognizing different proofs of investments made.


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Table 1. year 1st 2nd 3rd 4th 5th 1 Tax basis 100 100 100 100 100 2 Calculated tax 30 30 30 30 30 Reductions: 3 Newly established company 30 21 9 0 0 4 Investment by foreign person 18 18 18 18 18 5 Total reductions (not to exceed the amount of

calculated tax) (3+4) 48 39 27 18 18

6 Tax liability (2-5) 0 0 3 12 12 7 Tax liability as a percentage of the tax basis 0% 0% 3% 12% 12%

When the owner transferes profits of the company abroad, there is an additional obligation of calculating and paying taxes after reduction at the rate of 15%. The obligation of calculating and paying the tax lies on the payer, which is the resident company. One should note that BiH has no signed agreement on avoiding double taxation with Austria, or any other country, so the possibility of recognizing the tax paid in the Federation depends on the tax regulations in the home country of the owner. 10 In case that a tax payer from the Federation BiH has an office or a business unit in the Republika Srpska, that business unit is liable to pay the profit tax in accordance with the regulations of the RS. However, the tax regulations in the Federation BiH do not foresee the possibility of reducing the tax liability in the Federation of BiH by the amount paid in the RS. Therefore, the company is double taxed.

5.2.2 District Brcko As already mentioned before, the Brcko District applies the Law on Company Income Tax of the Federation BiH, so the tax solutions are identical.

5.2.3 Republika Srpska The Calculation of Income Tax Tax application for the income tax has to be submitted by March 10th of the following year. The source of procedure is following: ?? initial amount is the amount of profit (loss) from the income statement, which is

comprised on the basis of accounting regulations and standards; ?? after that, the possible expenditures not recognized for the purposes of taxation are

determined, i.e. exceeding them in the sense of taxation; ?? the profit/loss is increased for the determined expenditures not recognized for the

purposes of taxation, what defines the “taxable profit”-tax basis (as opposed to the FBiH, there is no possibility to reduce the taxable profits by the losses shown in the previous years)

?? taxable profit (the basis) is reduced for performed (during the tax year) investment in fixed assets and purchase of shares (on the tax basis, which is different from the Federation, where this benefit is applied to the calculated tax, in advance)

?? this gives the bas is for calculation of taxes, and then, by applying the 10% rate the amount of calculated tax;

?? there is the possibility of reducing the tax by possible savings, realized in accordance with older regulations.

10 Late last year, activities have been started on signing an agreement on avoiding double taxation between BiH and Austria, however, such agreement has not been signed to date.


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Determining the Expenditures not Recognized for the Purposes of Taxation Writing off the receivables is different in RS than in FBH. As opposed to the Federation BiH, in the Republika Srpska there are no additional conditions for the recognition of the expenditure on the basis of writing off the receivables in the tax balance. The Law on Company Income Tax has prescribed that the value of individual receivable is recognized, in accordance with the accounting regulations that do not require initiation of a lawsuit. Although the tax rate (10%) is three times less than the rate in the Federation (30%), the possibilities and number of tax exemptions are much fewer, so in the same example as before, the tax liabilities would be the following: Table 2. year 1st 2nd 3rd 4th 5th 1 Tax basis 100 100 100 100 100 2 Reduction of tax basis 11 - - - - - 2 Calculated tax 10 10 10 10 10 Reductions: 3 Newly founded company - - - - - 4 Investment by foreign person - - - - - 5 Total reduction (not to exceed the

amount of calculated tax) (3+4) - - - - -

6 Tax liability (2-5) 10 10 10 10 10 7 Tax liability as a percentage of the tax

basis 10% 10% 10% 10% 10%

Tax liability as a percentage of tax basis in the Federation BiH (table 1)

0% 0% 3% 12% 12%

In case of using reinvestment as a tax exemption, a possibility which has been provided for in both entities, there are some differences: ?? Federation – the calculated tax is reduced ?? RS – the tax basis is reduced .

So in this case too, the situation is better, from the aspect of the taxpayer, in the Federation. When the owner transfers profits of the company abroad, there is no obligation of calculating and paying taxes after reduction ,as it is the case in the Federation BiH. In this respect, the fiscal position of the foreign investor is better in RS, than in FBH. The tax regulations in the Republika Srpska, contrary to the regulations in the Federation of BiH, stipulate that the tax paid elsewhere (including the Federation BiH) is deducted from the total tax liability.

5.3 Sales Tax

5.3.1 Federation BiH The Law on Sales Tax in FBiH prescribes that the sales tax is paid on all services provided for a fee. The tax rate is unique, and amounts to 10%. The Law specifies the services that are exempted from taxation. Some exemptions are related to institutions, and some on types of services. The Law does not deal with the factoring services specifically, nor does it mention them anywhere, so the tax treatment must be inferred from the other provisions. The service of factoring is taxable service. The factor is the taxpayer. The obligation to calculate the sales tax ceases at the moment of issuing the invoice or other calculation on the performed service. If the service is normally not invoiced, the obligation of calculation occurs

11 It is assumed that there is no reinvestment as a tax exemption (identical to the previous example)


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at the moment of service provision. Payment of taxes occurs by the end of the week following the week when the collection has been made. If the service has not been paid, it has to be paid by the next week starting from expiration of 30 days from incurring the obligation to calculate the tax. All export services, including factoring services, are exempted from paying the service tax, under condition that they have been paid in accordance with the regulations on foreign trade and foreign currency exchange. i.e. that the service has been paid by the foreign customer through a commercial bank. The “export services” are understood to cover all services provided by a resident of FBiH to a foreign non-resident physical or legal person. Credit services and the interests accrued, are also exempted from paying the service tax. However, since the Law on Banks allows the business of providing credits to banks exclusively, borrowing from any other subject and pertaining interest payable is in practice not considered credit services by tax administration. Accordingly, interests from these transactions it are taxed at 10% rate. Therefore, the interest charged by the factor for amounts given in advance as a loan would be subject to 10% taxation.

5.3.2 Republika Srpska In the Republika Srpska too, the sales tax is paid on all services provided for a fee. The interest rate is the same for all services, and amounts to 8%. To this percentage, a contribution for railways of 2% is also added, which ultimately amounts to the same rate (10%) as in the Federation. The service provider is the one who pays the taxes. The exception is when a physical person provides a service to a legal person – the tax is paid by the recipient of the service, the legal person, and when a foreign legal or physical person provides a service to a domestic legal person, the tax is paid by the service recipient, the domestic legal person. That is also the case in FBiH. The liability incurs at the moment of providing the service, or at the moment of issuing an invoice on service provision. Just as in the Federation, factoring services have not been dealt with specifically. All services, not covered by the list of exemptions, are taxable. Factoring is not on that list. It means that the factoring services are taxable at the rate of 8% plus 2% contribution for railways. Export services are exempted from taxation as in the Federation, and tax is not paid on factoring services in this case. of course, factor fees and should be paid through commercial banks, in accordance with the foreign trade payment and foreign currency exchange regulations Same as in the Federation, the credit services (interest) are exempted from service tax. Also, according to the Law on Banks of the Republika Srpska, all legal persons except banks are prohibited from giving loans. Therefore, any other landing can not be considered credit, from what follows that the interest they are bearing are not credit services as understood in the Law on the Sales Tax, and consequently, are taxable (8+2%)

5.3.3 Brcko District Until recently, the Brcko District had been applying the Law of the Republika Srpska. A special Law on Sales Tax on Products and Services in the Brcko District has recently been adopted and has entered force. The treatment given to factoring is the same as in the other two entities. Also, an exemption from taxation on credit services interests is foreseen, providing that the treatment of interest based on loaning factors to the client will probably be the same as in the Federation and the Republika Srpska. The prescribed rate of the sales tax on services is 8% , but there is no contribution for the railways, as in the Republika Srpska. Consequently, the tax burden is lower than in the other two entities.

5.3.4 Harmonization A particular problem is the lack of harmonization of regulations in terms of taxation of services between the entities. Namely, the Law on Sales Tax of the Republika Srpska foresees that, if a person from the Federation or Brcko District provides a service to the legal persons from the Republika Srpska, the tax payer is that legal person, buyer in Republika


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Srpska. The problem is that the Laws on Sales Tax of the Federation prescribes that the persons from the Federation and the Brcko District, the service providers, have to calculate and pay taxes on sales of services. In the opposite case, when a person from the Republika Srpska provides services to a person from the Federation or the Brcko District, the tax is paid only once, by the person from the Republika Srpska. Such interpretation follows from the provisions of the Entity Laws, but we think that, in the first case, the double taxation may be avoided under the subsequent interpretation provided by the Ministries, particularly the Ministry of the Republika Srpska.

5.3.5 Court Expenses There are no specially prescribed fees or taxes for the sale or purchase of receivables Also, refinancing of factors is tax free. Those solutions are factoring friendly. Also, the collection of receivables using regular methods is not burdened by any special fees or taxes. However, if the collection is made through court, with a lawsuit filed, there is the court tax duty for every official application. One should mention that the suit is filed in accordance with the location of the seat of the defendant, except where the contract specifies otherwise, and that the tax duty may vary accordingly. There are no specially prescribed taxes for factoring business suits. Federation In the Federation, all fees are determined at the level of cantons. Court taxes depend upon the value of the suit. Republika Srpska Principles for determining court taxes are the same as in FBH. Due tot the organization of the court system, fees and taxes are unified in RS. Brcko District Approach to the system is similar to RS.

5.4 Accounting Treatment of Factoring

5.4.1 Regulation In Bosnia and Herzegovina, there are two accounting systems, one in the Federation of BiH, and one in the Republika Srpska. In the Brcko District (BD) this area has not yet been legislated, and the submitters of the financial reports freely choose the regulations of one or the other entity. In FBiH, the Accounting Standards of the Federation of BiH have been in force since 1998. The Standards were adopted by the Auditing and Accounting Institute of the Federation BiH in its capacity of a government agency. Accounting standards of FBiH are in line with the International Accounting Standards – IAS), however, they are not identical. Although the Accounting Standards of BiH are in their biggest part in fact the translation of the International Accounting Standards, there are some parts where they deviate from the IAS. It is important to mention that some Standards were adopted and published by IASB, but they have not yet been adopted (neither in their original nor in their changed form) by the Institute. Those are: 39 – Financial Instruments: recognition and measurement), 40 – Investment Property, 41 –Agriculture.


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A change to the Law on Accounting is expected to take place in near future, when the International Accounting Standards will be fully adopted. Similarly, the new law is expected to transfer certain responsibilities of the Auditing and Accounting Institute (certification of accountants, education, adoption and alteration of standards, etc.) to a professional association at the level of the State of BiH. This Association is currently in the process of establishment (the two Associations, one from the Federation of BiH and one from the Republika Srpska are being merged). Very probably, this new Association at BiH level will apply for membership in IFAC. In the Republika Srpska, the accounting standards were adopted by the Federation of Accountants and Auditors, which is an association of citizens. As a background information, the largest problem of formal nature is that the Constitutional Court of the Republika Srpska had proclaimed unconstitutional some provisions of the Law on Accounting and all regulations based upon them (accounting standards among them). Therefore, the whole accounting system in RS had been brought into question; however, this problem has been resolved recently by giving back to the Association the responsibilities it used to have according to the Law. The accounting standards of the Republika Srpska are the International Accounting Standards, however, there is a significant time gap between the adoption and publishing of the new standards and change of the old ones by the IASB and translation and publication of the new standards and changes to the old ones by the Association. Contrary to the Federation, the Standard 39 – Financial Instruments: Recognition and Measurement was published in the Republika Srpska. An overview of accounting standards dealing with recognizing and measuring the receivables and loans in the Federation of BiH: Type of financial instrument

Applicable (current) FBiH standard (code)

Applicable MRS (future FBiH)

SHORT TERM RECEIVABLES

Code Art. 66, 77, 81, 118 and 128

39

SHORT TERM LOANS

Code Art. 66, 77, 81, 118 and 128

39

5.4.2 Application of Accounting Standards From this point onward in the text, since the standards related to this matter are the same (in RS on the basis of the Standard 39, and in FBiH on the basis of the Code of Accounting Principles and on provisions of different standards) are more or less the same, the comments apply to both entities. As far as factoring in FBiH is concerned, the most important thing is that the Standard 39 has not been adopted to regulate the recognition and valuation of the financial assets and liabilities. With this standard lacking, the recognition and valuation of financial instruments is mostly done on the basis of the general provisions of the Code of Accounting Standards (General Framework). Since the receivables, as an object of factoring, are financial instruments (IAS 39, definition: “Financial instrument is any contract from which financial assets of one company and financial liabilities and principal instrument of another company emanate”), what has been said above also applies to them.


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At this time, the Accounting Standards do not contain any special provisions on recognizing and valuating the receivables. However, some standards do mention the receivables in connection with evaluation of other elements of financial reports, or they provide definitions and qualifications of receivables. Those are the following standards: ?? AS 32 – Financial Instruments: publication and presentation, in its paragraph 5 is

said that the contractual right to receive money or other financial asset from another company is also considered (among other things) a financial asset.

?? AS 18 – Revenues, under provisions 7 – 11 mention the evaluation of revenues at the fair value of compensation that has been received or is claimed.

Already the provisions of the AS 18, which are primarily intended for recognition and evaluation of the revenues, give the basis for initial recognition of receivables from the buyers. This form of receivables is therefore evaluated as a fair amount of compensation that is claimed, which is typically determined on the basis of an agreement or the product. About the subsequent evaluation of receivables, the AS of FBiH do not state anything in particular. In addition to the above, one needs to keep in mind the provisions of the Code of Accounting Principles in FBiH that refer to the receivables: ?? 45) Assets and liabilities, revenues and expenditures should be evaluated on the basis

of the principle of prudence: ?? 66 a) Asset is the resource that is under control of a legal person as a result of past

events, from which the income of future economic benefits for the legal person is expected.

?? 77) A particular asset is classified as a current one if it is expected to be transformed into cash or cash equivalents, sold or spent during the regular business cycle of the legal person…

?? 118) An asset is recognized in the balance sheet once it becomes probable that the future economic benefits would flow into the legal person, and when the asset has the cost or value that can be reliably measured.

As mentioned above, the AS 39 that defines the criteria of initial evaluation and subsequent measurement of receivables as a financial instrument had already been published in the Republika Srpska. Conclusion! Both in FBiH and in RS the initial evaluation of the receivable is at the level of the fair amount of compensation provided. The difference in subsequent measurement of receivables between the FBiH and the RS standards lays in fact that the FBiH Standards do not prescribe explicitly that the value of the receivables is to be reduced in case that the book value exceeds the evaluated reimbursable amount, but instead, this obligation follows from the provision of the Code of Accounting Principles. In the RS, this is provided under paragraph 109, standard 39.

5.4.3 Examples Standards related to this matter are more or less the same (in RS on the basis of the Standard 39, and in FBiH on the basis of the Code of Accounting Principles and on provisions of different standards). This enables further examples and comments that apply to both entities. Because of tax limitation, as described above, the deductions from the value of receivables are presently rarely implemented in FBiH, although, as we have seen, this is mandatory according to the accounting standards. Accounting Method Usually in BiH, when it comes to subsequent evaluation of receivables, the collecting period of the receivables is assessed within a certain time period (typically at the end of the accounting period), and their value is reduced accordingly, with an appropriate increase in


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expenditures. This is done through an adjustment of the value of the receivables. In the balance sheet, the receivables are shown as net values (initially recognized amount of receivables reduced by the amount of the adjustment): Account Receivables 50.000 Assessment 10% of receivables will remain uncollected Booking: Bad debt expense 5.000 Allowance for doubtful accounts 5.000 Expenditures are included in the income statement (5,000), and the adjusted amount of receivables (45,000) will be shown in the balance sheet. In case that the receivables do get collected before the end of the accounting period, the expenditures and the adjustment of the amount are cancelled. Bad debt expense - 5.000 Allowance for doubtful accounts - 5.000 If the receivables are collected in the next accounting period, the revenues are recognized and the adjusted value is reduced: Amount of adjustment of receivables 5.000 Revenues 5.000 If it has been assessed that (individual) receivables will surely not be collected, the adjustment is made through direct write off of the receivable. Bad debt expense 5.000 Accounts receivables 5.000 As it is widely known, factoring is not used in practice in BiH, and consequently, there is no accounting presentation of such transactions. The accounting treatment would be in accordance with the standards identified above.

5.4.4 FX (foreign exchange) transactions The reporting currency in both entities in BiH is the convertible mark (KM), and all transactions made in any foreign currency need to be shown in the domestic currency (KM). The influence of the exchange rate of the foreign currencies to properties, liabilities and revenues and expenditures of domestic persons conducting foreign currency transactions are defined by the Accounting Standard 21 – Effects of Changes in Foreign Exchange Rates (in RS the IAS 21 is fully taken over, while it has suffered some minor changes in FBiH). One should mention here that the national currency is pegged to Euro through the mechanisms of a currency board (it will probably remain so during a longer period in future), therefore, such effects may occur only in case of transactions in other currencies than Euro. There is no additional accounting regulation in this area. Therefore, in accordance with the prescribed treatment, the foreign currency receivables are registered at the average rate of the Central Bank of BiH (CB) at the date of transaction. At the date of balancing, the positive or negative exchange rate differences are determined by comparing the average CB course at that date with the initially recognized value of the receivables. After that, at the date of


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collecting the receivables, a new recognition is made of revenues or expenditures (depending on the average CB exchange rate) that follow from the changes in foreign exchange rates. With respect to a Factor who buys the receivables in foreign currency from domestic legal persons, such treatment of foreign currency transactions would entail the necessity of adjusting the value of the receivables that had been bought on the date of the balance and on the date of collection of the receivables.

5.5 Recommendations

5.5.1 Corporate Income Tax ??Write off of receivables:

The Rulebook on Implementation of Law on Income Tax in FBiH must be changed in that topic. The obligation of suing a debtor for overdue receivables for the purpose of recognizing the write-off in taxation should be at the discretion of the creditor. Otherwise the creditor has, in addition to the loss of the receivables amount,– to pay taxes on the loss or bear uncollectable legal costs.

?? Activities of drafting and signing agreements on avoiding double taxation, based on

the OECD model, with the neighboring countries and more important trade partners, that are currently ongoing need to be accelerated.

?? Changes need to be made to the Law on Company Tax in FBiH in order to avoid

internal double taxation (for the profits earned in RS) ?? One needs to keep in mind that the preparations for adoption of a new Law on

Company Tax of Commercial Companies in FBiH are ongoing. The shortcomings of this law (at least in this respect) need to be anticipated.

5.5.2 Sales Tax ?? It is necessary to harmonize the provisions of the entity laws on sales tax in terms of

avoiding double taxation of services provided in the inter -entity trade. ?? By defining factoring as a financial institution that receives licenses for work from the

Banking Agency, it is certain that the interest on the factor loans would enjoy the same treatment as the bank loans (non-taxable).

?? As is the case with the company tax, one needs to keep in mind the soon introduction

of the value added tax. The Law on VAT should be unique for the whole of BiH. It is not known at this point in time what will be the treatment of factors and services provided by it.

The recommendations in this sense exceed the scope of this study; however, one must remember that the institutional principle of exemption, which would include the factoring business that provides services exclusively to other tax payers, would result with a certain cascade effect. Although such approach may be justified during the initial stages (mostly for technical reasons), it seems that such treatment, in case it is adopted, should not be kept after the initial stages.


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5.5.3 Accounting ?? The recommendation is made to adopt and apply the IAS in whole BiH, what will

become reality in a near future. Namely, a joint Law on Auditing and Accounting is currently under preparation, which provides for the implementation of the International Accounting Standards in whole BiH.

?? Joint venture approach to establishing the factoring companies should ensure the

technology of work in this area too.


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6 STRATEGY, BUSINESS POLICY AND GENERAL RECOMENDATIONS

Helmut Paris, Ph.D.

6.1 Strategy The Mission Providing export orientated BiH companies with a custom made trade finance service with a view of satisfying the interests of the founding shareholders. Objectives The objectives of the newly created company could broadly be defined as follows: ?? provide a new financial service to the BiH business community ?? become a respectful financial institution in BiH in the field of trade finance ?? help the local bank partners to maintain the image of a modern, fast reacting,

customer oriented institute, ready to support the needs of corporate clients all over Serbia with a special emphasis on international operations

?? fulfill the strategic objective of the international factoring partner of being present in the BiH market

Goals ?? establish an adequate organizational structure, standard procedures and control

mechanism ?? create a regular customer base of exporting companies ?? approach international factoring markets, establishing correspondent relationships

with leading factoring organizations ?? achieve export factoring turnover of ?? EURO 4 million in 2004 ?? EURO 10 million in 2005 ?? EURO 20 million in 2006 ?? create conditions for the introduction of domestic factoring and import factoring after

successful implementation of export factoring ?? reach the break-even point in the second full business year ?? obtain membership of Factors Chain International

6.2 Business Policy Human Resources Plan In the initial period of the new established factoring company, the number of employees shall be minimized to those, which are considered necessary for undisturbed performance of the activities foreseen. These will include: ?? a single managing director ??manager marketing and customer relations ?? senior officer accounting and book-keeping ?? senior factoring officer ?? administrative assistant


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In addition, a senior factoring officer shall be seconded for a time period of at least two years by the international factoring shareholding partner. Provided satisfactory growth of business, the employment of an additional factoring officer may be considered, with the objective of assisting the senior factoring officer to carry out the tasks related to handling the factoring documentation. The payment scheme shall be based on tariff-terms comparable to those of the BiH shareholding bank and shall include salary and obligatory health and pension insurance. Scope of business The new established factoring company shall primarily engage in EXPORT-factoring at the beginning. Domestic and Import factoring may be performed on a case to case basis upon prior approval by the Supervisory Board. The activities within Export Factoring shall include: ?? Purchasing of receivables (unsecured claims resulting from sale of goods and

rendering of services on open account) o Category of goods: Consumer goods, components and semi-finished products

for manufacturing, tourism and transportation, services, catering, pharmaceutics, metal goods, light machinery, etc.

o Max. payment term: 90 days o Max. prefinancing to seller (Exporter): 80% of the outstanding balance of not

overdue claims. o Sellers have to include in a factoring agreement all deliveries to an individual

buyer or even to all buyers in a particular country of destination. ?? Purchasing on a case by case basis of other short-term claims, resulting from export

of goods or services. This includes claims secured by L/C, bankers acceptance, draft, promissory note etc. if issued and/or confirmed (aval, acceptance) by a prime international bank.

Pricing policy ?? Interest rate

In the case of non-recourse factoring and therefore payment risk transferred to a foreign import factor [for undisputed deliveries], the interest rate charged to the seller (exporter) shall be comparable to the rates prevailing and charged by Serbian banks to their borrowers. The rate can be increased at the discretion of the managing director, if average terms of payment exceed the usual 30, 60, 90 days, depending of the volume of business and on the possibilities of refinancing the business.

?? Factoring fee

The factoring fee paid by the seller (exporter) consists of the part charged by the import factor for risk-taking and collection on the one hand and the part marked up by the export factor on the other hand. The overall factoring fee amounts usually between 1% and 2% and is charged on 100% value of the receivables turned over to the export factor. The factoring fee structure shall be different, depending on volume of business and payment terms of the receivables. The factoring fee can vary also, depending on the country of destination of exports, e.g. when selling to countries where import factors usually charge higher fees compared to average.

?? Handling fee

EURO 6 – 12 per invoice is usually charged to the exporter as a handling fee.


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Funding policy ?? own funds ?? refinancing with import factors ?? domestic and foreign money markets

The funding policy shall be guided by policy of maximizing the net interest margin. Risk policy ?? Financing

With regard to the receivables financing, the new established factoring company shall normally perform its operations on a non-recourse basis, provided that the payment (del credere) risk is transferred to an import factor. The company in principle shall not finance those export transactions, which are not covered by import factors taking over of payment risk. In exceptional cases such transactions may be carried out only under recourse to the seller and further provided that such company (seller) is considered prime risk.

?? Collection

The company shall perform collection of receivables on a risk free basis. The payment risk will be taken only if transfer of risk to import factor had been agreed, or if risk remains with the seller. Deviations from this rule can be made only in exceptional cases. Performance risk is the sole responsibility of the seller (exporter). For covering this potential risk the financial situation of the seller shall be monitored frequently.

?? Currency risk

The company shall try to minimize and neutralize currency risk resulting from carrying out its business operations by insisting on conclusion of such factoring agreements with its clients, according to which currency risk (profit or loss due to the appreciation or depreciation of the local currency in respect to foreign currencies) will be transferred on them. Furthermore exporters shall be financed in the same currency as the currency of the underlying export receivables. The company shall further try to match the assets and liabilities currency structure with the objective to avoid currency gaps and the risk resulting there from.

?? Interest Rate Risk

The company shall try to minimize or neutralize interest rate risk by matching the interest rate type of specific transaction financed with the type of interest rate paid for refinancing funds.

?? Country risk

Since the overwhelming majority of transactions (export factoring) will, as expected, involve partners (factors and buyers) in countries with insignificant country (political, economic) risk, no special precautionary measures are being contemplated with a view of protecting the company from this kind of risk. However in the case of exports to countries with higher country risk, the company shall try to minimize exposure by extending the sellers prefinancing and other lines only with shorter than average tenor.

?? Import Factor Risk

In order to minimize this kind of risk, the company shall seek to establishing and maintaining business relations with selected factoring organizations only and particularly with reputable FCI members.


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6.3 Final Analysis and General Recommendations The Obligation Code and the Banking Law are not setting up obstacles for factoring. According to art. 39 of Banking Law, banks can perform the financing function, the ledgering, the collection of receivables and the del credere protection. Factoring as core business of a newly established company can be performed within the existing legal system. For the registration of the financing function, number 65.2265.2220 “other credit business regulated by specific enactments”, as listed in the “standardized classification of Activities in FBiH”, is available. The factoring company acts under the “loan contract regime”, there are no legal restriction on lending. Initially a factoring enterprise should be established as a limited liability company. After the factoring business is well established, the limited liability company can be reorganized as a joint stock company. It is recommended to form a joint venture between a local bank and an experienced international factoring company. Participation of IFC in the share capital should be welcomed. To become associate member of Factors Chain International, share capital of Euro 2 million is required. Participation in this Chain will enable the newly founded company to handle BiH export business in a very secured sage way. After having established reasonable factoring business in BiH, the Ministry of Finance and the Banking Agency should be asked to regulate the factoring business. This should result in defining factoring companies as “financial organization” under the authority of the Central Bank, needing a license and being controlled by the Banking Agency. Improvements are recommended as far as the speed of court procedures are concerned. Write off of receivables: the Rulebook on Implementation of Law must be changed in that topic. The obligation of suing a debtor for overdue receivables for the purpose of recognizing the write-off in taxation should be at the discretion of the creditor. Otherwise the creditor has, in addition to the loss of the receivables amount,– to pay taxes on the loss or bear uncollectable legal costs.

Documents

ST BiH Factoring Eng - World Bankdocuments.worldbank.org/curated/en/440521468199442423/... · 2016-07-16 · factoring business modeling and analysis of different options of legal